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To arrive at the cash flow from operating activities using indirect method, we make adjustments for inventory. The inventory adjustment is made on the basis of cash paid or not for the inventory. What if the purchases are on credit. Then increase in inventory will not include cash payment. Why we always assume the increase in inventory inventory cash payment. I couldn’t understand it logically, please help.
The increase in inventory is to account for the fact that we bought more than we used. For that adjustment it is irrelevant whether the bought it for cash or on credit, because that is dealt with by the adjustment for the change in payables.
I understand that for the adjustments, it is irrelevant whether cash is paid or not. Then why explanation is like we buy more, so less cash? Is it because we will add increase in payables that will result in net cash flow for purchases during the year?
Yes, and that is what I was meaning in my previous reply. The inventory adjustment changes the cost of sales in the SOPL to the amount actually purchased. The payables adjustment changes what was purchased into the cash actually paid.
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