What is the primary effect of LIFO on Unlevered Free Cash Flow?

The primary effect of using the Last In, First Out (LIFO) inventory valuation method on Unlevered Free Cash Flow (UFCF) is that it generally increases UFCF.

When a company uses LIFO, it assumes that the most recently acquired inventory is sold first. This can lead to lower taxable income during periods of rising prices because the cost of goods sold (COGS) is based on the latest, higher-priced inventory, resulting in lower profits reported for tax purposes. Since UFCF is defined as operating cash flow minus capital expenditures, the tax savings achieved through reduced taxable income can effectively enhance cash flow in the near term. Consequently, the lower income tax expense increases the UFCF, as more cash is retained within the business.

The implications of LIFO can vary in different contexts, particularly during inflationary periods, which is why it may appear to create variability in cash flows under certain circumstances. However, the fundamental impact of LIFO itself tends to be an increase in UFCF due to tax advantages.