One of the greatest competitive advantages of a company lies in an efficient and optimized warehouse and stock management.
For a correct methodology of work in a warehouse, there are different methods of warehouse management. Among the best known are the LIFO and FIFO methods.
The method a company uses to evaluate its inventory costs will affect its profits.
We are going to focus on the LIFO method, what advantages it offers and how it differs from the other method called FIFO
Take note!
What is the LIFO method in warehouse management?
The LIFO (Last In, First Out) method is an accounting method of inventory valuation that assumes that the last items purchased or produced are the first to be sold or used, i.e., it gives output priority to the last units of product that have arrived in the warehouse.
This method makes use of the first-in, last-out technique, storing first those goods that will be used last.
At the physical level, storage systems are needed that allow the newest product to be placed at the front.
Which warehousing systems facilitate LIFO management?
In order to carry out a correct management of the FIFO method, it is advisable to apply the following storage systems:
- Push-back system. It is one of the best known and most effective dynamic storage systems. They have a single loading and unloading point right in front of the structure, allowing the units to be stored to push those already stored.
- Drive – In system. One of the most interesting features of this system is that only one side is accessible for loading and unloading, eliminating the accumulation of aisles. Allows the storage of unit loads in depth.
Advantages of using LIFO
The use of the LIFO method offers great logistical and accounting advantages:
- It facilitates the reduction of distances.
- Increases the occupancy rate.
- Products can be stacked as they arrive which increases the speed of this process.
- The cost of the materials issued will be closer to or more reflective of the current market price.
Related content:
- WMS. Warehouse Management System. What it is and its advantages
- Order Picking. What it is and what types exist
- Cross Docking. What it is, types and how it works
When to use the LIFO method
The LIFO storage system is generally used when storing goods that do not lose their value over time and are not of a perishable nature.
It is highly recommended for those companies that can maintain a considerable level of stock and do not need a certain rotation of their products.
Particularly suitable for the storage of construction products, where the LIFO method is perfectly adapted to the characteristics of this type of products.
Differences between the LIFO and FIFO method
The LIFO and FIFO methods are the most commonly used warehouse management strategies. Taking into account that the LIFO method assumes that the newest stock is sold first and the FIFO method defines that what has entered our warehouse first should be what we dispose of first, what are the main differences?
- Sales order: In the FIFO method, the first items purchased or produced are assumed to be the first to be sold or used, while in the LIFO method, the last items purchased or produced are assumed to be the first to be sold or used.
- Obsolete inventory: The LIFO method can cause inventory losses due to obsolete or deteriorated products, something that cannot occur in the FIFO method.
- Pricing: The FIFO method protects from the always unstable market prices.
- Taxes: Taxes may differ between the two methods, as the LIFO method may result in a higher cost of goods sold and, therefore, a lower taxable profit.
- Application: The FIFO method is more commonly used by companies selling perishable goods or with a high inventory turnover, while the LIFO method is more commonly used by companies selling non-perishable goods or with a low inventory turnover.
Example of calculation according to the LIFO method
To better understand what the LIFO method consists of, not only at a logistical level, but also at an accounting level, we show you the following simple example:
Suppose a company has the following inventory records for a particular product:
| Date of purchase | Quantity | Unit price |
|---|---|---|
| January 1 | 1000 | $10 |
| March 1 | 2000 | $12 |
| June 1 | 1500 | $13 |
| September 1 | 3000 | $15 |
At the end of the year, 4,500 units of this product were sold.
To calculate cost of goods sold (COGS) using the LIFO method, it must first be determined which were the last units to enter inventory, i.e., those most recently purchased or produced.
In this case, the last 4500 units purchased are the 3000 units purchased in September, and the 1500 units purchased in June. which will be the first to be released under the LIFO method. Then, the number of units sold must be multiplied by the unit cost of those last units.
Then, the cost of goods sold for this product using the LIFO method is:
September: 3000 x 15= 45.000€.
June: 1500 x 13= 19.500€.
Total: 64,500€ cost of products sold.
If they have been sold at 20 euros, they have been invoiced: 4,500 x 20=90,000 euros.
Therefore, using the LIFO method, the profit is: 90,000 – 64,500 = 25,500 euros.
Profits under the FIFO method would have been different.
It is important to keep in mind that this is only a simplified example and that in practice the calculation of cost of goods sold can be more complex, especially in companies with large inventories and many purchase and sale transactions.
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