In today’s economic environment, businesses are looking for ways to improve their cash flow. Manufacturers and distributors are facing rising costs for inventory and supply chain matters. Business leaders should explore their inventory valuation method as one opportunity to help improve cash flow.

Companies with inventory have multiple methods of valuation in accordance with generally accepted accounting principles in the United States (U.S. GAAP). Two of the most common methods are first in, first out (FIFO) and last in, first out (LIFO). The FIFO method, which is the most commonly used method, relieves inventory and costs inventory using the older items purchased as the first item sold. The LIFO method relieves and costs inventory using the prices of the most recent purchases.

In a business environment of rising costs, companies are buying inventory at higher prices, selling inventory at lower costs, and recognizing more income. LIFO provides a company to with an opportunity to expense higher cost items during a period of inflation. This will reduce the company’s income for both financial reporting and tax reporting, as implementing LIFO requires books and tax maintained on LIFO method. Therefore, the LIFO method will reduce a company’s tax liability and improve current cash flow. Below is an example of the potential impact of making the switch from FIFO to LIFO.

*Assumed tax rate is 37% federal and 5% state

With LIFO applied, inventory and profits would be $498,000 lower and cost of goods sold would be higher by the same amount. The cash flow and tax savings would be based on the initial LIFO reserve in the year of adoption. Each year, if inflation continues to rise, the LIFO reserve will continue to grow and the benefits of deferring taxes will expand. Companies should be aware that the potential tax savings is a deferral of taxable income, and the savings is temporary. If inventory valuation and costs level off or decline, the related tax will need to be paid.

Inflation is at an all-time high. Companies should review all options and strategies in these challenging times. Using LIFO may help mitigate rising costs and improve cash flow through potential tax savings in the near term.

How Citrin Cooperman Can Help

Citrin Cooperman’s Manufacturing and Distribution Practice can help you identify the best LIFO tax saving opportunities for your business. If you would like to explore the options available to your business, contact your Citrin Cooperman advisor today or Stephen Kelly at skelly@citrincooperman.com.