The three financial statements are the income statement, balance sheet and statement of cash flows.

In the case of cash flow, if a business uses  the first-in-first-out inventory method (FIFO) when prices are rising and inventories are also rising, the cost of goods sold (COGS) would be low and net income would be higher. As a result, the company would have to pay higher taxes. This would result in a lower cash flow for the firm.

In the case of balance sheet, change in inventories and incorrect inventory balances affect your balance sheet, the financial statement that is a view of your company’s worth based on its assets and liabilities. An incorrect inventory balance can result in inaccurate reported value of assets and owner’s equity on the balance sheet. However, it does not affect liabilities.

With respect to income statement, if there are any errors in calculating inventory, there would be cascading effects on COGS, profits and income. There are several reasons why your inventory might be inaccurate. Some instances include breakage during transit, not adding returned goods to inventory and old goods which might have to be sold at a discount. In all such cases, you need to adjust your inventory to an accurate value. Understand that using the last-in-first-out inventory method (LIFO) will have higher COGS and would be more representative of the current economic reality. Hence, profitability will be more accurate, making it a better indicator for forecasting.