Question

How can inflation impact financial reports and can that impact financial decisions?

Answer 1

Impact of inflation on financial reports and financial decisions -

1. Interest expense in company's financials appears to be overstated as in inflationary environment value of debt drops but historical interest cost do not capture this relationship.

2. While doing inventory valuation at FIFO (first in first out) company's closing stock appears to be highly valued which will help in boosting gross profits.

3. If company is weak in pricing power then high inflation will lead to high expense cost while its revenue will not rise in line with expenses thereby leading to loss in profitability.

All of the above factors are impacted by the levels of inflation, therefore adding or removing the effects of inflation one can arrive at useful financial decision. For example - firm can consider to increase its dividends inline with inflation as its profits has risen due to higher inflation.

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