Inventory management is a critical component of a business’s operations. After all, it controls and monitors a company’s stock levels. In fact, the inventory management software market size might grow at a CAGR of 5% by 2032.

Businesses must check their needs for inventory management. And select the approach that suits them the best. FIFO (First-In, First-Out) and LIFO (Last-In, First-Out) are two of the most used inventory methods. But what do they exactly mean and entail? And how different are they from each other?

Let’s explore the differences between FIFO and LIFO methods in detail.

FIFO Method

In the FIFO method, a business uses or sells the first products received or created. In other words, the business sells or uses the oldest products in the inventory first. And it sells or uses the newest ones last.

How does the FIFO method work?

Let’s understand this using an example:

A business sells products A, B, and C. In January, it buys 100 units of A for $1, 200 units of B for $2, and 300 units of C for $3 each. Then, in February, it bought 200 more A units for $1.50. The FIFO method assumes the business sold 150 A units in March. The first 100 units sold were January bought at $1, and the next 50 units were February bought at $1.50 each.

LIFO Method

In the LIFO (Last-In, First-Out) method, a business sells or uses the last items received or produced. In other words, the business sells or uses the newest products in the inventory. While it sells or uses the oldest ones last.

How does the LIFO method work?

The same business sells products A, B, and C. In January, it buys 100 A units for $1, 200 B units for $2, and 300 C units for $3 each. Then, in February, it purchased 200 more A units for $1.50. According to the LIFO method, selling 150 A units in March means the 150 A units will be disposed of from the 200 A units lots purchased in February at $ 1.50.

Comparing FIFO and LIFO Methods

LIFO implies the sales or usage of the newest inventory first. And FIFO bases this assumption on which inventory is older. This basic distinction affects COGS (Cost of Goods Sold) and inventory valuation.

Advantages of the FIFO method:

• The FIFO method assumes that a business will sell or use the oldest inventory first. So the cost of goods sold reflects the actual cost of the oldest items in inventory.
• The FIFO method can better match the costs of goods sold with the revenues generated by those goods.
• A business that follows FIFO sells or uses the oldest items before they become outdated. Thus, the FIFO method can reduce the risk of obsolescence.

Advantages of the LIFO:

• The COGS is higher under the LIFO method as inventory purchased recently is assumed to be costlier to the same purchased earlier. So, businesses that use this method may have lower taxable income and lower tax liability.
• The LIFO method assumes that the newest inventory is sold or used first. This means that older inventory is sold or used late and could become obsolete. This could increase carrying costs.
• The LIFO method assumes that the business sells or uses the most recent inventory first. Thus, it can reflect current market conditions better.

Choosing the suitable inventory valuation method depends on several factors. These include the nature of the products, the industry, and the business objectives.

For example, the FIFO technique may benefit companies that deal in perishable items. But companies looking to reduce their tax obligations may prefer the LIFO method.

Implementing an Inventory Management System

Using an inventory management system has several benefits for businesses, including:

• An inventory management system can help improve inventory control, more specifically, in real time. This reduces the risk of stockouts or overstocking.
• It can automate inventory management tasks like stock tracking and reordering. Thus, businesses can save time and reduce errors.
• It allows businesses to gain insights into their inventory data. This feature helps guide decisions about stock levels, prices, and promotions.

Inventory management systems track products and manage levels at many locations. This provides precise financial data for taxes and analysis.

How to install an Inventory Management System?

Businesses must follow these steps to install FIFO or LIFO method in an inventory management system:

1. Choose the appropriate inventory method. They should consider their inventory needs and business objectives.
2. Set up inventory tracking. This includes the initial inventory quantity and cost.
3. Record inventory transactions. This includes purchases, sales, and returns in Inventory ledgers.
4. Generate reports that show the inventory levels, COGS, and sales data for each product. This allows businesses to analyze their inventory data and make informed decisions.

Wrapping up

We compared FIFO and LIFO methods, highlighting differences. Choosing a suitable method is crucial. Especially for efficient inventory control, improved stock management, and financial reporting aligned with business goals.

After reading this blog, we hope you have a comprehensive understanding of the FIFO and LIFO inventory methods. But, if you still have questions or uncertainties, consult with professionals specializing in this field, such as GJM & Co.

At GJM & Co., our experienced accountants can guide you through inventory management, stock management, and other related areas. They’ll provide you with a deeper understanding of these topics.

Should you have any queries or need consultation, Schedule a Call today or write to us at info@gjmco.in.