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E&O reserves represent inventory owned by a company that it can no longer sell. These include excessive quantities of inventory and obsolete inventory. These include products the company ordered too much of and items which no longer meet customer needs. When the company transfers inventory to E&O reserves, it records a decrease in the net inventory value. This decrease in inventory appears on the cash flow statement in the operating activities section as an increase in cash. However, transferring the inventory to the E&O reserve does not result in an increase in cash. The E&O reserve balance needs to be added back in order to accurately reflect the cash transactions of the company.
Read the current balance sheet. Locate the balance of E&O reserves. Locate the net inventory value reported on the balance sheet.
Add the E&O reserve balance to the net inventory value. This equals the total inventory value at the end of the period.
Read the prior period balance sheet. Locate the balance of E&O reserves. Locate the net inventory value reported on the prior period balance sheet.
Add the prior period E&O reserve balance to the prior period net inventory value. This equals the total inventory value at the end of the previous period.
Subtract the total inventory value for the previous period from the total inventory value for the current period. If the change in inventory is positive, the total inventory value increased. If the change in inventory is negative, the total inventory value decreased.
Add a negative change in inventory to the operating activities section of the cash flow statement. Subtract a positive change in inventory to the operating activities section of the cash flow statement.
Review the level of inventory held as E&O reserves periodically. E&O inventory costs the company money to store. Identify potential markets for the E&O inventory, such as foreign markets or discount outlets. Arrange to sell this inventory and reduce costs associated with owning this inventory.
Some industries experience higher amounts of E&O inventory than others. Technology industries experience rapid changes which make older products obsolete faster. Some buyers purchase too much inventory, creating excess.