Inventory Management Techniques: LIFO or FIFO?
Which is the Best Method for Your Business?
Business owners often overlook a critical component of operations management – their inventory management system, which can have a huge impact on a company’s operations, tax liability, and profitability.
One critical thing to consider is if you should employ the LIFO inventory management technique (“Last in, First out”) or the FIFO inventory management technique (“First in, First Out”).
What is LIFO?
The LIFO inventory method assumes that inventory items added to your inventory most recently are the first items to go “out.” The LIFO inventory method is ideal for businesses with homogeneous products, or inventory items that have little differentiation in features from other companies’ products, including metals, building products, equipment, auto parts, stone, etc. When you receive a new shipment, you can add the items to the top of the pile. The items at the top of the pile will go out first.
The biggest advantage of the LIFO inventory method is that it can potentially lower your tax liability by allowing you to report lower profits. Why? With LIFO, the prices are recorded as the original paid and, assuming that prices increase over time, the original price is going to be lower than the most recent price. This will decrease your gross income and tax liability. There are several other advantages of using the LIFO inventory method, such as how it reduces the need to manually rotate inventory and it is simple to understand execute on a daily basis.
What is FIFO?
The FIFO inventory method dictates that the products you bought or manufactured first are the first products to go “out.” The FIFO method works well If you have perishable goods (i.e. fresh produce or pharmaceutical products), or items with a limited amount of time before they become outdated or expire. If you do have items with a limited shelf life, it is essential to use the FIFO inventory method to avoid losing money before they expire, become an outdated model, or go become obsolete while sitting on a shelf. There are other advantages of the FIFO inventory method, including how it makes companies appear more profitable and richer in assets to potential investors. Additionally, FIFO is a more straightforward method of moving inventory compared to LIFO.
Properly tracking your inventory is crucial since it can reduce your tax liability and increase your profitability. TRXio can help effectively manage your inventory by generating real-time reports and providing item-level traceability. Use our reports to quickly ascertain what inventory needs to be moved out,, and with item-level tracking tools this ensures that you have the visualization to determine the length of time an item was brought received into custody. TRXio’s “Reserve on Receive” feature also shortens handling time by assigning products newly received into inventory, then immediately reserves them for a work order. The “Orders” screen also sports a list of products in stock that can be sorted by the length of time they have been in inventory, so users can quickly tell where to pull items from for to utilize the FIFO method of inventory management.
Please contact us at 844-868-7225 for more information on managing your tax liability through inventory management.