Maybe a stupid question
Hi, Lately I was thinking about a standard interview question. "Please tell me what happens to all 3 financial statements if COGS decreases by x units (in this case let's assume that x=10), I think I have the answer but I would really appreciated if somebody can confirm / correct it. Is it the case that when COGS go down inventory will increase? If we take the following formula Op. Inventory+Purchases-COGS=Closing Inventory, we will subtract lower number for COGS, which will lead to higher Closing Inventory, is this right? Also, would really appreciate if someone can share a more comprehensive EV formula. During one interview I got a bit grilled with asbestos liabilities, which I haven't heard about previously.
Thank you, D.
If COGS decreases, then pretax income is greater, but because of taxes that gain is less, so net income increases by (1-t) x (Decrease in cogs). For the cash flow statement, start with your new net income. No other SCF changed, so cash increases by the same amount as bet income increased. For the balance sheet, assets increased (since cash increases), and equity increased (since net income increases--> retained earnings), so it balances.
I see your point, but I am afraid that you can balance the whole thing even if you make a logical mistake. The trick with this question is to find out why COGS dropped and usually I would expect that if COGS drop Revenue will decrease as well. For now let's neglect the revenue side. If we have that COGS are supposed to be lower than they were, then it means that that goods that were not sold are supposed to remain in inventory, thus they shall be added back to inventory, no?
Usually if they are asking that question they are looking for direct affects on the statements
the cash flow statement would be affected by the change in inventory levels? no?
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