Last updated on Aug 19, 2024

Your inventory is hit with unexpected demand changes. How do you choose between FIFO and LIFO methods?

When your inventory faces sudden demand shifts, deciding on an inventory management method is crucial. First In, First Out (FIFO) and Last In, First Out (LIFO) are two common strategies that can significantly impact your business's financial health and customer satisfaction. In the face of these challenges, understanding the nuances of each method becomes essential to navigate the turbulent waters of supply chain management.

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1 FIFO Explained

FIFO, meaning First In, First Out, is an inventory management method where the oldest stock is sold first. This approach aligns with the natural flow of perishable goods, ensuring that items do not become obsolete or expire. When demand unexpectedly rises, FIFO can help maintain product quality and minimize waste. However, it may not always be cost-effective if older stock was purchased at lower prices, leading to lower profit margins during inflationary periods.

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2 LIFO Explored

Conversely, LIFO, or Last In, First Out, prioritizes selling the most recently acquired inventory first. This method can be beneficial during times of rising prices, as it matches current sales with current costs, potentially reducing taxable income. However, if demand changes are unexpected and drastic, using LIFO might result in selling newer inventory at a loss or holding onto outdated stock, which could be detrimental if the products are time-sensitive.

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3 Assessing Costs

Cost assessment is a vital step in choosing between FIFO and LIFO. You must consider the cost of goods sold (COGS) and how it affects your bottom line. FIFO typically results in a lower COGS during periods of inflation, leading to higher profits and taxes. LIFO can reduce taxes by increasing COGS when prices rise, but it may not reflect the actual flow of goods, complicating stock management.

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Sudeshna Dixit

Future-Proofing logistics with You | Supply Chain Expert & Thought Leader
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LIFO and FIFO are two ways to value inventory. LIFO assumes the most recent items bought are sold first. This can lower taxes when prices rise but might overstate costs during sudden sales spikes. FIFO assumes the oldest items are sold first. This shows a more accurate inventory value when prices drop but can lead to higher taxes in inflation. The best method however depends on factors like how the prices are changing with the tax rules, and how we want the financial reports to show.

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4 Inventory Type

The nature of your inventory plays a pivotal role in selecting the appropriate method. For perishable or trend-sensitive items, FIFO is usually the better option as it helps rotate stock and reduces the risk of obsolescence. In contrast, LIFO might be more suitable for non-perishable goods or commodities where price volatility is a concern, as it can help buffer profit margins against cost fluctuations.

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5 Financial Reporting

Financial reporting standards and tax regulations must also be factored into your decision. In some jurisdictions, LIFO is not permitted for financial reporting purposes. It's imperative to comply with the Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) applicable in your region. Non-compliance could lead to legal issues and affect your company's financial credibility.

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6 Strategic Considerations

Finally, your long-term business strategy should guide your choice between FIFO and LIFO. Consider how each method impacts your cash flow, inventory turnover, and customer satisfaction. FIFO might ensure a consistent quality of goods for your customers, while LIFO could help you manage cash flow better in an inflationary environment. The key is to align your inventory management method with your overall business goals and market conditions.

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Sudeshna Dixit

Future-Proofing logistics with You | Supply Chain Expert & Thought Leader
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Selecting between LIFO and FIFO inventory valuation methods in the face of fluctuating demand requires a strategic approach. FIFO generally provides a more accurate representation of ending inventory value, especially for perishable goods, and is often preferred during inflationary periods. Conversely, LIFO can offer tax advantages by matching current costs with revenue but may distort the true value of inventory. Factors such as product lifecycle, industry norms, and potential impacts on financial statements must be carefully considered alongside the specific nature of demand fluctuations to optimize the choice of inventory valuation method and its implications for overall business performance.

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Your inventory is hit with unexpected demand changes. How do you choose between FIFO and LIFO methods?

1

2

3

4

5

6

1 FIFO Explained

2 LIFO Explored

3 Assessing Costs

4 Inventory Type

5 Financial Reporting

6 Strategic Considerations

Inventory Management

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Your inventory is hit with unexpected demand changes. How do you choose between FIFO and LIFO methods?

1

2

3

4

5

6

1 FIFO Explained

2 LIFO Explored

3 Assessing Costs

4 Inventory Type

5 Financial Reporting

6 Strategic Considerations

Inventory Management

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