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FIFO Method
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LIFO Method
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Weighted Average Method
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Here’s what else to consider
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1 FIFO Method
FIFO stands for first-in, first-out, which means that the inventory items that are purchased or produced first are sold first. This method assumes that the oldest inventory has the lowest cost, and the newest inventory has the highest cost. The advantages of using FIFO are that it reflects the current market value of the inventory, it matches the physical flow of inventory in most cases, and it minimizes the risk of inventory obsolescence. The disadvantages are that it inflates the net income and the taxable income in periods of rising prices, it requires more record-keeping and tracking of inventory batches, and it may not capture the true cost of production.
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FIFO is typically seen with commodities such as lumber. With a FIFO method, it all starts with receiving and organization of the product flow. Replenishment standards are also crucial for a technique like this to be successful. Managing the process, not the product, will help ensure you are organized and thriving in a FIFO. In a tight supply chain world, this is the most challenging program for buyers because they may have you need to buy now mentality or risk out-of-stock positions. Extraordinary processes and documentation equal great results.
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2 LIFO Method
LIFO stands for last-in, first-out, which means that the inventory items that are purchased or produced last are sold first. This method assumes that the newest inventory has the lowest cost, and the oldest inventory has the highest cost. The advantages of using LIFO are that it reduces the net income and the taxable income in periods of rising prices, it matches the cost of goods sold with the current cost of production, and it simplifies the record-keeping and tracking of inventory batches. The disadvantages are that it understates the current market value of the inventory, it creates a mismatch between the physical flow and the cost flow of inventory in most cases, and it increases the risk of inventory obsolescence.
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3 Weighted Average Method
The weighted average method calculates the cost of goods sold and the ending inventory based on the average cost of all inventory items available for sale during the period. This method does not distinguish between the old and the new inventory, and it assigns the same cost to each unit sold or remaining. The advantages of using weighted average are that it smoothes out the fluctuations in inventory costs, it avoids the extreme results of FIFO or LIFO in periods of changing prices, and it requires less record-keeping and tracking of inventory batches. The disadvantages are that it does not reflect the current market value of the inventory, it does not match the cost of goods sold with the current cost of production, and it may not capture the true cost of production.
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4 Here’s what else to consider
This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?
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- Adio Taibat Clinical/Administrative pharmacist, global Healthcare manager, specialist technical assistant aseptic services officer for cancer services.
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First expiry first out (FEFO) is also a good way to avoid product expiry leading to wastage of resources. However, this does not put into consideration the cost of purchase of the product.
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