LIFO vs. FIFO Inventory Management: Choosing the Right Method for Your Business

🧾 LIFO vs. FIFO Inventory Management: Which Method Should Your Business Use?

If your business carries inventory, the way you account for it isn't just a bookkeeping choice—it can directly impact your taxes, cash flow, and overall financial strategy. Two widely used inventory accounting methods are FIFO (First-In, First-Out) and LIFO (Last-In, First-Out). Both are allowed under U.S. Generally Accepted Accounting Principles (GAAP), but they serve very different purposes, especially in times of inflation.

In this post, we’ll walk you through how each method works, their pros and cons, and how to decide which is right for your business.

📦 What Is FIFO (First-In, First-Out)?

FIFO assumes that the oldest inventory items (first-in) are sold first (first-out). That means the cost of goods sold (COGS) reflects older, often cheaper inventory, while the newer (more expensive) stock stays on your balance sheet.

✅ Key Advantages:

• Higher reported profits during inflation
• Inventory on the balance sheet reflects current market value
• Aligns with the actual physical flow of many products (e.g., perishable goods)

🚫 Potential Drawbacks:

• Higher taxable income in inflationary periods
• May artificially inflate profits and tax obligations

🛢️ What Is LIFO (Last-In, First-Out)?

LIFO assumes that the most recently acquired inventory (last-in) is sold first (first-out). This means that your COGS reflects the most recent, usually higher-cost inventory, which can result in lower taxable income.

✅ Key Advantages:

• Lower tax liability during inflation
• Matches current inventory costs with current sales revenue
• Helpful for businesses where inventory costs fluctuate dramatically

🚫 Potential Drawbacks:

• Not permitted under International Financial Reporting Standards (IFRS)
• Can result in outdated inventory values on the balance sheet
• May lower reported profits, which could impact investor perception

📊 FIFO vs. LIFO: A Quick Comparison

COGS Basis

• FIFO: Oldest Inventory
• LIFO: Newest Inventory

Net Income During Inflation

• FIFO: Higher
• LIFO: Lower

Tax Liability During Inflation

• FIFO: Higher
• LIFO: Lower

Inventory Valuation

• FIFO: Reflects recent costs
• LIFO: Based on older costs

Global Acceptance

• FIFO: Accepted under GAAP and IFRS
• LIFO: Allowed only in the U.S. under GAAP

Common Industries

• FIFO: Retail, Grocery, Manufacturing
• LIFO: Oil & Gas, Commodity-based industries

🏪 When Should You Use FIFO?

FIFO is ideal for businesses that:

• Sell perishable or time-sensitive inventory
• Operate in industries where inventory cost increases gradually
• Want stronger earnings for reporting or financing purposes

Examples: Grocery chains, ecommerce retailers, apparel stores

🏭 When Should You Use LIFO?

LIFO is more beneficial for businesses that:

• Manage large volumes of goods subject to volatile pricing
• Want to minimize tax obligations during inflation
• Operate exclusively under U.S. GAAP with no international reporting needs

Examples: Oil distributors, raw materials suppliers, manufacturing firms

📌 Other Key Considerations

• 🔁 Switching methods requires IRS approval — it’s not a casual decision.
• 🧮 LIFO typically requires more complex tracking and accounting systems.
• 🧾 Your inventory method affects how your financial health is perceived by investors and lenders.

🤔 Final Thoughts

Choosing between LIFO and FIFO isn’t just an accounting decision—it’s a strategic one. Your selection can influence everything from tax liability to cash flow to investor confidence.

Before you decide, consider:

• Your industry
• Inventory type and turnover
• Inflation trends
• Long-term business goals

✅ Need help deciding?
Contact us today! The experts at Peak Accounting can walk you through the pros and cons based on your specific financial situation, and ensure your inventory accounting aligns with both your tax strategy and reporting obligations.