Inventory on Cash Flow Statement
Inventory is the goods company purchase for the purpose of reselling, it includes the raw material produce goods available for sale. For manufacturing, there are three types of inventories which include raw material, work in progress, and finished goods. For the trading company, inventory is the goods they purchase to resell.
Inventory is the current asset that presents on the company’s balance sheet. The inventory that is sold within the accounting period will be classified as “Cost of Goods Sold” in the income statement.
Impact of Inventory on Cash Flow Statement
Inventory is the current asset, so it impacts on operating activity of the cash flow statement. The movement of inventory will cause cash inflow and outflow of the company.
Similar to other current assets, company needs to spend cash to acquire the inventory. So when the inventory increase, it means that company has to spend cash (cash outflow) to purchase them. On the other hand, the decrease of inventory will make cash inflow as we have sold them.
We come up with the following rule:
- Inventory increase => Cash Outflow (negative)
- Inventory decrease => Cash Inflow (positive)
What if we purchase inventory on credit, so there is no cash flow. We may sell the inventory on credit, so cash not yet receive too. When we buy or sell inventory on credit, it will impact the Accounts Payable and Accounts Receivable balance. The movement of both accounts also present on the cash flow statement, so they will impact both sides.
Example of Inventory on Cash Flow Statement
ABC company purchase inventory 100,000 at $ 5 per unit. During the year, they sold 30,000 units at $10 per unit to the customers. Assume both purchase and sale transactions are settled immediately. The inventory beginning balance is 40,000 units cost $ 5 per unit.
Please show the impact of inventory on the cash flow statement.
First, we need to analyze how much cash flow in and out of the company.
- Company spends $ 500,000 to purchase the inventory (100,000 units x $5/unit)
- Company earns 300,000 from selling inventory to customers (30,000 units x $10/unit)
- So in total, company spend $ 200,000 (500,000-300,000)
Inventory increase from 40,000 units to 110,000 units at the end of the year. It eqivalent to $ 350,000 [(110,000-40,000) * $5 per unit].
|Partial Statement of Cash Flow|
|Change in working capital:|
|– Decrease in AR||XXXX|
|– Increase in Inventory||(350,000)|
Based on the partial cash flow statement above, we can see $ 350,000 cash outflow caused by the increase in inventory balance. However, there are some transactions that already affect the Net income, so let break it down:
|Cost of Goods Sold||(150,000)|
|Impact on Net income||150,000|
As we can see, the amount of $ 150,000 already impacts net income as a positive side (cash inflow). When we net off with a change in inventory balance which is on the negative side (cash outflow), we will get $ 200,000 (-350,000+150,000) as the negative impact on a whole cash flow statement.