Question

Under the indirect method, to convert profit to net cash provided (used) by operating activities, increases in inventory must be added to profit because the expense included in the calculation of profit is greater than purchases during the period.

Select one:
A. True
B. False

Answer 1

The student's statement is false. Increases in inventory indicate more purchases than sales and should be subtracted from profit when using the indirect method to calculate net cash from operating activities.

The statement about the indirect method for converting profit to net cash provided by operating activities and the effect of inventory increases is false. Under the indirect method, when inventory increases, it implies that the company has purchased more inventory than it has sold. Since the expense recorded in the profit and loss statement includes the cost of goods sold, which is lower than the purchases when inventory increases, the company actually spent more cash than the expense shown. Therefore, the increase in inventory should be subtracted from the profit, not added, to arrive at the net cash provided by operating activities.