If you want the inventory management system to work well, you should know that there are more things to take into consideration than just entering the amount you pay for your inventory into your accounting software. There are numerous ways you can value your inventory, and each one of them has a different impact on your business.
The most common inventory management methods are FIFO and LIFO. You might have heard about them already, but to use them correctly, you need to have a clear idea of what they stand for.
After all, inventory management is a vital part of any product-oriented business. The method you choose can have a crucial effect on your income, taxes, logistics, and overall business success. So, let’s dive into each method, and see which one works for you the best.
What is FIFO?
FIFO method stands for the First-In-First-Out. This means that the oldest products in the company are sold first. So, FIFO (First-In, First-Out) assumes that the oldest products have been sold first and continue by those production costs.
The FIFO method is easier to understand and implement for most businesses. It is only natural that most companies consider the oldest products first anyway. This idea comes from the risk that older inventory might lose value over time. Generally, FIFO is considered to be a more trusted way to sell products and calculate the cost.
The FIFO method is widely used by businesses that sell perishable goods. For example, companies that sell food, that expire over time. Also, FIFO might be a good choice for companies selling products with short demand cycles.
Benefits of FIFO
- FIFO is the most widely used method, which says a lot about the importance of this method.
- This is the simple way to run from oldest to newest products.
- This method matches inventory costs as the current market value.
- FIFO matches costs to inflation.
- FIFO minimizes losses caused by obsolete and perishable stock.
Disadvantages of FIFO
- FIFO might overstate gross margin, which creates misleading financial statements.
- Costs might seem less than they are in reality.
What is LIFO?
LIFO method stands for the Last-In-First-out, which means that the newest products should be sold first. In other words, the last units that arrived in inventory are sold first. When companies use the LIFO method, the cost of the recent products is the first to consider the cost of goods sold (COGS).
The LIFO method is not practical for every business as it uses the most recently acquired inventory to value costs. As a result, LIFO can’t provide an accurate value of inventory as the previous and today’s prices are different for each product.
The LIFO method is widely used by supermarkets and pharmacies. This is because the goods they stock experience inflation. Many convenience stores that carry fuel and tobacco use LIFO because the costs of these items have risen substantially.
Benefits of LIFO
- LIFO has a tax advantage benefit, as it results in a higher cost of goods sold and a lower balance of remaining inventory.
- LIFO matches recent costs against current revenues.
- The business that uses LIFO is less likely to be affected by the drop in price in the future.
Disadvantages of LIFO
- LIFO is not a very realistic inventory system and can cause some misunderstandings.
- Thsi method might require more complex record-keeping.
- LIFO isn’t the best idea if the business wants to expand internationally, as many international accounting standards don’t allow LIFO valuation.
How can you use these methods?
Inventory is one of the vital parts to analyze as it explains what’s happening with a company’s core business. However, both method needs a different calculating process, and you should use the right model to succeed.
Although FIFO is the most-trusted method, don’t decline to use FIFO, as it might be the better choice. We are familiar with the properties of different products and would like to help in the process of inventory management. Ecomhub.net is always ready to choose the most suitable and flexible models for each company.