Businesses use two main ways of accounting for their inventory. Here is an explanation of what they mean.
LIFO and FIFO are two ways that companies keep an account of their inventory. Inventory includes raw materials, materials half-completed, and finished products. Companies differ in how they keep track of what goes out to sale, what gets sold, and what remains. LIFO (Last-in, first-out) and FIFO (First-in, first-out) have their differences and advantages.
LIFO
The Last-in, first-out method transfers goods by stocking batches in one order, and carrying them out in the reverse order. Picture four bricks priced in the order of $1 to $4. The $1 brick goes into the shelf first, with the $2 brick in front of it, and so on. When orders come in, it is the last brick in, the $4 one, that will go out first. This can be seen in grocery stores, in which shelves are stocked with a row deep of items, and customers take the items out what is available closest to them.
The fincancial result of this form of inventory transfer is that at the end of the day, whatever is left over will have the price of the first items, that is, the cheaper items. If half of the bricks are sold, the remaining worth of the LIFO bricks equals $3.
FIFO
Meanwhile, the First-in, first-out method is like a continuous stream of products. Instead of a deep shelf, imagine that the four bricks are on a conveyor belt, in one side and out the other. The $1 brick goes in first and is sold first. Therefore, if half of the bricks are sold by the end of the day, the remaining inventory is worth $7, the combination of the $4 and $3 bricks.
Main Differences
The reason that items coming in may be more expensive than the ones that entered before them is inflation. The LIFO and FIFO methods have opposite advantages and disadvantages during inflation and deflation.
For example, the LIFO has a high Cost of Goods Sold (COGS), and so has a low tax, whereas FIFO has a low COGS and high tax during a time of economic inflation. This is flipped when the economy deflates. It is when COGS is low and tax is high that the company attracts investors.
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