Are you an eCommerce business owner looking for a reliable inventory control method that will result in the most efficient asset management? Look no further, as LIFO (Last In First Out) may be an ideal solution to help optimize your operations.
Its simple yet effective approach can provide maximum results when used appropriately.
By understanding how and when to utilize this underrated method, you’ll be able to streamline your business processes while saving money – two key elements needed by any organization trying to thrive in today’s tough market climate!
Want to learn more about how implementing LIFO into your standard operating procedures can benefit both yourself and your customers? Let’s dive in.
What Is The Last-in, First-Out Method?
The last-in, first-out (LIFO) inventory costing method is used to account for inventory that regularly fluctuates in value. This financial approach is one of four inventory costing methods typically utilized by businesses. It assumes that the inventory which was most recently acquired is also the first inventory sold – hence ‘last in, first out’.
Imagine your eCommerce business sells clothing and accessories for fashionable toddlers. Because the value of a particular piece of clothing will fluctuate frequently based on newness, demand, seasonality, and other market factors, trying to value your inventory could be like constantly trying to hit a moving target.
The LIFO method allows companies to measure their inventory on a cost basis rather than market or replacement cost, leading to more reflective inventory values over time.
It should be noted that the LIFO method does not necessarily track the physical flow of a company’s inventory and is generally used for inventory items like office supplies and raw materials that are replaced frequently; for such items, ensuring accuracy of inventory at any single moment would favor use of FIFO (first-in, first-out) or other inventory costing methods instead.
What are the advantages to using the LIFO Method For eCommerce?
Businesses that frequently experience sales price fluctuations due to ever-changing market conditions could benefit from the Last In, First Out (LIFO) accounting method. This method allows companies to record sales at the most recent (or highest) sales prices, thereby providing a more accurate financial picture.
Two examples of eCommerce businesses that could greatly benefit from utilizing the LIFO method are retail stores and automotive dealerships.
Retail stores often struggle to control cost of goods by selling products that were purchased at higher prices when sales slow down, while automotive dealerships can undervalue their inventory costs if sales unexpectedly decrease.
By using the LIFO method for inventory costs and sales valuation, both types of businesses can be better equipped to manage market fluctuations.
Here are some of the biggest advantages of using the LIFO method:
1. Cost savings: By using the LIFO valuation method, eCommerce stores can save on inventory costs by selling their oldest stock first and reserving newer, more expensive inventory for later sale.
2. Increased efficiency: With the LIFO system, eCommerce stores can easily track their stock levels as they are constantly replenishing the oldest inventory first. This makes it easier to manage inventory levels, as well as reduce the need for additional labor or storage space due to overstocking.
3. Improved customer experience: By constantly offering their customers the newest products and services, eCommerce stores can maintain a higher level of customer satisfaction and loyalty.
4. Reduced risk of obsolescence: By using the LIFO valuation method, eCommerce stores can reduce their risk of having inventory become obsolete. By selling the oldest stock first, they can avoid stocking items that may not be popular or relevant in the future.
5. Improved forecasting capabilities: With the LIFO system, eCommerce stores have an easier time predicting future sales and stock levels. By tracking their current inventory, they can better determine what products need to be reordered in the future. This helps them keep costs down by only reordering when necessary.
What are the disadvantages to using the LIFO Method For eCommerce?
The inventory cost method of Last In First Out (LIFO) can be a disadvantage for certain types of eCommerce businesses.
For example, it may not benefit businesses that rely on products with a quickly depreciating inventory cost such as fresh groceries or apparel. Likewise, LIFO inventory costs could lead to inflated inventory costs for online companies that sell technology, since these items tend to depreciate in value more slowly over time.
eCommerce businesses should consider their inventory cost strategy carefully and weigh their options when deciding if the LIFO inventory cost method is right for them.
Here are some key disadvantages to consider:
1. LIFO does not allow for the tracking of specific items within a larger inventory, which can make it difficult to determine if an item was sold or consumed in-house.
2. This method ignores the value changes that can occur with time; therefore, it is not suitable for businesses involved in trading commodities or products whose prices fluctuate over time.
3. LIFO can also result in higher taxes, as the most recently added items are assumed to be sold first, resulting in higher profits being taxed at a higher rate.
4. This method of inventory tracking is not suitable for businesses that use multiple warehouses or storage locations, since it fails to track items between locations.
5. Lastly, businesses that rely heavily on seasonal sales or products with expiration dates may find it challenging to accurately use the LIFO method as items with a shorter lifespan must be reported first regardless of when they are added to inventory.
How to Calculate LIFO For eCommerce Stores
Calculating taxable income for an eCommerce store can be complex, but the use of the LIFO inventory valuation method allows store owners to simplify the process.
Through this method, store owners are able to purchase new inventory and set it as the last cost of goods sold in their taxable income calculations.
This means that the most recent cost of the inventory will be used in order to estimate a more accurate inventory value. By utilizing this method, business owners can easily calculate taxable income and ensure that their financials are precise and reliable.
Calculating Last In, First Out (LIFO) for eCommerce stores can help businesses to determine their old inventory costs when determining product pricing. Because eCommerce stores typically track inventory digitally, they must use alternative methods to calculate LIFO compared to traditional physical inventory businesses.
- Measure the value and cost of each item in the old inventory before introducing any new items.
- After assigning a value and cost for each item, organize the old items from highest cost to lowest cost. As you move through these old items, subtract the value from the cost for each item to determine the profit you make from selling them.
- This process will then give you a clear understanding of the old inventory costs associated with running your eCommerce business.
FAQs
Here are a few of the most common questions we get on the LIFO method:
Q: What is Last In First Out (LIFO) inventory method?
A: The Last In First Out (LIFO) Inventory method assumes that the most recently purchased or manufactured items are sold, used, or issued first. This means that the cost of goods sold, or consumed is based on the last item purchased or manufactured, rather than the cost of earlier purchases or manufacture.
Q: What are some LIFO examples?
A: For example, a retail store may purchase 10 items at different prices — $2, $3, $4, etc. During the year they sell 8 units of these items. With LIFO inventory accounting, the last two items purchased at $4 each will be the first ones sold.
Q: What are the advantages and disadvantages of LIFO inventory method?
A: Advantages of LIFO include providing a better match between current costs and sales revenues which reduces taxes in periods of rising prices. (Such as during a recession.) A disadvantage is that it could be difficult to track the cost of inventory if LIFO is used with large volumes and frequent purchases. Additionally, LIFO can create discrepancies between book value and market value of inventory on a company’s balance sheet.
Q: What are some LIFO inventory management strategies?
A: Some LIFO inventory management strategies include creating LIFO layers and LIFO pools. A LIFO layer generally consists of items purchased or manufactured at the same time, while LIFO pool categories are used to track costs related to similar items that may have been purchased or manufactured over different periods. Additionally, LIFO inventory management strategies should include cycle counting and establishing reorder points in order to maintain the LIFO layer.
Q: How do LIFO and FIFO differ?
A: The First In First Out (FIFO) inventory method assumes that the first items purchased or manufactured are sold, used, or issued first. This means that the cost of goods sold is based on the oldest item purchased or manufactured rather than the most recent one. In contrast, LIFO assumes that the most recently purchased or manufactured items are sold, used, or issued first. Overall, LIFO results in higher costs of goods and lower profits when compared to FIFO.
Q: How does LIFO affect financial statements?
A: LIFO affects financial statements in two ways — it affects the amount of cost of goods sold, and it affects inventory valuations. The LIFO method reduces taxes by reducing the reported profits on financial statements since LIFO assumes that the last item purchased or manufactured is used first. Additionally, LIFO can create discrepancies between book value and market value of inventory on a company’s balance sheet.
Q: When should LIFO inventory method be used?
A: The LIFO inventory method should only be used when it is allowed by local accounting regulations, and if prices of the product are increasing over time. It can also be beneficial in periods of rising costs or deflation, since LIFO allows for keeping lower profits and lower taxes. Finally, LIFO can be beneficial in cases when there is an abundance of inventory and LIFO layers can easily be created.
Q: Are there any alternatives to LIFO?
A: Yes, the most widely used alternative to LIFO is First In First Out (FIFO). FIFO assumes that the oldest item purchased or manufactured is used first. This means that the cost of goods sold, or consumed is based on the oldest item purchased or manufactured, rather than the last one. FIFO may be more reliable in some cases when LIFO layers cannot be established and tracked properly. Additionally, LIFO can create discrepancies between book value and market value of inventory on a company’s balance sheet, and FIFO can be used to avoid this.
Conclusion
The Last-in, First-out method is a great eCommerce inventory management technique to ensure you are always selling your newest products first.
This system has many advantages, like decreased obsolescence and increased tax deductions. However, there are also some disadvantages to using LIFO which include the potential for errors in calculation and less control over what products are being sold.
Overall, it’s worthwhile to evaluate whether the LIFO method is best for your eCommerce business.
