In logistics and inventory management, understanding how goods are stored and retrieved is crucial for efficiency and profitability. One of the key strategies used in managing inventory is the Last In, First Out (LIFO) method.
In this guide, we’ll take a look into the basics of LIFO, its applications, advantages, and how it differs from other inventory management techniques like First In, First Out (FIFO).
What is last-in, first out (LIFO) in logistics?
LIFO is an inventory management principle where the most recently acquired items are the first to be sold or used. This approach is often employed in industries where the cost of inventory tends to increase over time, such as during periods of inflation. By using the newest stock first, companies can manage their inventory costs more effectively and potentially reduce their tax liabilities.
How does LIFO work?
In a LIFO system, goods are stored and retrieved from the same side of the storage rack. This means that the newest items are placed in front of or on top of the existing stock. When an order is fulfilled, the most recent items are removed first. This method simplifies warehouse operations by reducing the distance that goods need to travel within the facility.
What are the advantages of LIFO?
The Last In, First Out method offers several benefits that make it an attractive choice for businesses managing non-perishable inventory. Below are some of the key advantages.
Effective cost management
One of the most significant benefits of LIFO is its ability to help manage inventory costs, particularly during periods of inflation. By selling the most recently acquired items first, companies can report higher costs of goods sold (COGS). This can lead to lower taxable income, which can be beneficial for reducing tax liabilities.
Efficient use of warehouse space
LIFO allows for a more streamlined use of warehouse space. Since goods are loaded and unloaded from the same side of the storage rack, it reduces the need for extensive racking systems and minimizes the distance that warehouse operators need to travel. This setup can significantly improve operational efficiency and reduce labor costs.
Simplified inventory tracking
The LIFO method simplifies inventory tracking and valuation. It is particularly useful for managing homogeneous goods that do not expire or lose value over time. This simplicity can reduce administrative efforts and costs associated with inventory management.
What are the disadvantages of LIFO?
While LIFO offers several benefits, it also comes with some drawbacks that are important to consider.
Complexity in accounting
One of the main challenges of using LIFO is its impact on financial reporting. By selling the most expensive items first, a company may report higher costs of goods sold (COGS), which can make it appear less profitable. This can complicate financial analysis and potentially affect investor perceptions.
Limited applicability
LIFO is not suitable for all types of products. It is best used for non-perishable goods that do not expire or lose value over time. For perishable or expiring items, using LIFO could lead to waste and inefficiency, as older stock might not be used before it expires.
Potential for obsolescence
In industries where products quickly become outdated, using LIFO can lead to issues with inventory obsolescence. If newer items are sold first, older stock might become outdated before it is used, resulting in potential losses.
Inventory valuation challenges
In a LIFO system, inventory valuation can become complex, especially if prices fluctuate significantly. This can make it difficult to accurately determine the value of remaining inventory, which is important for financial reporting and tax purposes.
What are the industries where LIFO is commonly used?
LIFO is particularly beneficial in industries where goods are non-perishable and costs tend to fluctuate. Let’s take a look at the three sectors where LIFO is commonly applied.
1. Construction and building materials
Companies dealing with products like ceramics, glass, and stone often use LIFO. These materials are homogeneous and do not expire, making them ideal for this inventory management method. By selling the most recently acquired materials first, construction businesses can better manage rising costs associated with these products.
2. Automotive and manufacturing
In these sectors, raw material costs can vary significantly over time. LIFO helps manage these fluctuations by ensuring that the most recently purchased (and often more expensive) materials are used first. This approach allows companies to align their production costs with current market prices, which can be especially important during periods of inflation.
3. Retail electronics
Retailers selling electronics often face challenges due to rapidly changing technology and rising component costs. LIFO can be an effective strategy for managing inventory in this environment. By selling newer stock first, retailers can match their sales with the current market prices of technology, helping to maintain profitability despite fluctuating costs.
What is the difference between LIFO and FIFO (first-in, first-out)?
Each method has its own set of advantages and is suited for different types of products and business needs. Here’s a comparison of LIFO and FIFO to help you decide which method is best for your business.
Key differences
- LIFO is ideal for non-perishable goods and industries where costs are rising. It involves selling the most recently acquired items first, which can help manage inventory costs effectively.
- FIFO, on the other hand, is best for perishable goods or products with expiration dates. It ensures that older items are sold before they expire or become obsolete.
LIFO vs. FIFO comparison table
| Method | Description | Best For | Key Benefits |
|---|---|---|---|
|
LIFO |
Last items stored are the first to be retrieved. |
Non-perishable goods, rising costs. |
Cost management, efficient use of space. |
|
FIFO |
First items stored are the first to be retrieved. |
Perishable goods, reducing waste. |
Reduces spoilage, ensures freshness. |
How to choose between LIFO and FIFO
When deciding between LIFO and FIFO, you should consider the nature of your products and your business goals:
- Use LIFO if you deal with non-perishable goods and want to manage rising costs effectively.
- Use FIFO if you handle perishable items and need to ensure that older stock is sold before it expires.
In summary, Last In, First Out (LIFO) in logistics is an inventory management method where the most recently received items are sold or used first, often used for non-perishable goods to manage costs effectively.
