Definitions Of FIFO And LIFO
Having a business comes with a lot of responsibilities. You have to make sure that everything goes as planned on every occasion. So it’s only natural you want the best for your business. When managing your company’s inventory there are a lot of different methods that one can follow to grow their business. Two of them are FIFO and LIFO. These two acronyms refer to inventory management methods regarding selling your stock.
FIFO (First-In-First-Out) refers to the method of selling your older inventory first. That means that the products that you receive first are the ones that will be sold first. This is a very useful method for companies that have products with expiration dates e.g. supermarkets.
LIFO (Last-In-First-Out) refers to the method of selling your newest inventory first. This means that the products you receive last will be sold first. This method is usually used by companies whose products are affected by inflation, so they can better match up their costs e.g. pharmaceuticals.
Process And Examples
- A clothing business purchases 20 shirts for 5 dollars each and later purchases another 15 shirts for 10 dollars each. The business receives an order for 15 shirts. With the FIFO method, that order will be fulfilled with products from the first batch of shirts. This means that each shirt costs 5 dollars. If later on, they receive another order for 10 shirts, it will consist of the leftover 5 shirts from the batch and 5 shirts from the second batch. Therefore, the cost of 5 shirts will be 5 dollars each and the other 5 shirts 10 dollars each.
- A bakery makes 15 cupcakes on Monday. The next day, they make 20 more cupcakes and receive an order for 25 cupcakes. The order will consist of the first 15 cupcakes made on Monday and an additional 10 that were made on Tuesday.
A business that sells keychains purchases units every year. In 2017, the business received 150 keychains for 1 dollar each. In 2018 and 2019 the company purchased another 150 keychains each year which comes to 300 in total. Due to inflation, the price rose to 1.10 in 2018 and 1.15 in 2019. In 2020 the company sold 350 units. With the LIFO method, this means that the first 150 units cost 172.5 dollars, the next 150 units were 165 dollars, and the last 50 units cost 50 dollars. The total cost of that order comes to 387.5 dollars.https://blog.megaventory.com/lifo-definition/
As you can see, things can get a bit complicated. You have to always make sure that the inventory you’re selling is of the right batch. That’s why we would advise you to use an inventory management system, so you can make sure everything runs smoothly.
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Pros And Cons Of FIFO and LIFO
There are a lot of different benefits of each method. It’s important though to make sure that the method you use corresponds to your company’s needs. Here are some of the pros and cons for each method:
Pros And Cons Of LIFO
- The products left are the most recent ones.
- This makes the expense of sold items show the oldest prices, while the stock amount represents the newest prices.
- FIFO is good for businesses selling things that spoil, like food or flowers, or things with quick sales, like fashion or electronics.
- It usually brings more profit and income when item costs increase, as it pairs lower costs with higher earnings.
- This can make the stock value seem higher than what it’s worth now, and taxes might be higher.
Pros And Cons Of LIFO
- The items left are the ones that have been around the longest. This makes the expense of sold items show the most recent prices, while the stock amount represents the oldest prices.
- LIFO works well for businesses selling things that don’t spoil, like metals or books, or things with slower sales, like machinery or furniture.
- It usually brings less profit and income when an item’s costs increase, as it pairs higher costs with lower earnings.
- This can also make the stock value seem lower than what it’s worth now, and taxes might be less.
As you can see, when we see the differences of FIFO vs LIFO there are quite a few. Nonetheless, it’s important to make sure that the plan you follow aligns with the goals of your business. Each method has different benefits and can help you reach different results.
Vasilina Maglara is a Digital Marketer from Greece. She works at Megaventory, a company that makes ERP software for medium-sized businesses. Eager to learn and grow, Vasilina is helping Megaventory and its customers succeed through effective marketing and content creation.