Hi all...when inventories decrease from one year to the next we recognize this in the Cash Flow statement by increasing cash.
However, my question here is that aren't we double counting this since this sale was already included in the Revenues/Sales portion of the income statement?
Any help will be appreciated
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I understand what you mean and where the confusion comes from but no, because COGS is not a cash expense either. Essentially, you’re adjusting for the COGS (which isn’t a deduction in cash) which is reflected to attain NI, which flows into the operating CF.
Think about it like this: if a company’s inventory didn’t change over a period yet it had sales of 100 on COGS of 80, then that means the company purchased 80 of inventory to use as COGS. Thus, the 20 NI (assuming no other exp/taxes) is an accurate reflection of the cash flows (+100 in sales, -80 in buying the inventory to sell) and no adjustment is necessary.
Thus, if inventory decreased, that would imply the company used inventory on hand, so you need to account for the COGS (which again, isn’t cash) that was subtracted to arrive at NI. Using the same extreme example above, if the company bought nothing and used only inventory on hand, it would be +100 cash from the sales, not +20 like NI would imply. Thus you adjust for this by adding back the change in inventory.
Hope that makes sense.
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