How Well Am I Really Doing?
Fay Stocks sells oriental rugs. She uses the FIFO method of inventory costing. The inventory available for sale for a particular style of rug is as follows:
|
Inventory Date |
Current Inventory |
Cost |
|
June 14 |
4 |
@ $1,200 each |
|
June 21 |
3 |
@ $1,500 each |
|
July 5 |
6 |
@ $1,700 each |
On July 31, a wealthy customer purchases three rugs paying $2,600 for each. Fay immediately replaces those rugs with three new rugs at a cost of $2,300 apiece. In addition, Fay immediately pays income tax on the sale at a rate of 40%. (Assume that she has no other expenses.) What is Fay’s net income (after taxes) from the sale of the rugs? What is Fay’s net cash flow from the sale of the rugs, the payment of income taxes, and the subsequent purchase of three new rugs? Why is there a substantial difference between net income and cash flow? What other circumstances can lead to differences like those illustrated in this case?