How do you choose which inventory to sell first? It seems like a simple decision, but it can have a major impact on your store’s profits.

The choice often comes down to the FIFO or LIFO method. While FIFO means you prioritize your oldest stock, LIFO is about selling your newest ones first. You have to commit to one, as it’s generally bad practice to keep chopping and changing your inventory management.

Our article breaks down the FIFO vs LIFO methods to help you see which one’s right for you. We look at their advantages and disadvantages and which situations they work best for.

The LIFO and FIFO methods are explained

LIFO and FIFO are both inventory management methods. That means they outline a way for you to track and organize your stock.

FIFO (First-In-First-Out) is when you sell your oldest items first, so there’s no risk of them becoming unsellable. Many types of stock can perish or become obsolete on the shelves, losing you money.

LIFO (Last-In-First-Out) is essentially the opposite. Instead of prioritizing your oldest items, you sell the newest ones first. This drives up your expenses and reduces your taxable income.

What’s the main difference between FIFO and LIFO?

The difference between FIFO and LIFO doesn’t just come down to order. These two methods have very distinct aims and focus.

As with many business operations, the overall goal of FIFO and LIFO is to improve your financial performance. 

However, FIFO gets you to do that by reducing your waste and increasing sales. The idea is that if you shift more stock before it perishes, you can generate more revenue.

LIFO is about lowering how much of your business income goes to tax. As prices are constantly rising, your newest stock is often the most expensive. By selling these items first, you can raise your expenses and claim more as deductions.

These different aims can affect your focus. FIFO requires you to look more at your inventory’s age and quality, whereas LIFO is more concerned with financial reporting.

How to calculate COGS using the FIFO and LIFO method

You can use FIFO and LIFO to calculate your Cost of Goods Sold (COGS), a.k.a. The total amount you spent on stock.

It’s the same basic formula for both the FIFO and LIFO methods. All you have to do is multiply the amount of items sold by the cost per item.

The main difference between the FIFO and LIFO formulas is the order. When you calculate FIFO, you assume you sold the oldest products first. You apply the cost per item that you sold the item for then.

And vice versa. When you calculate LIFO, you assume you started with the newest products and used the most recent purchase values.

Afterward, you can add up the COGS from each batch. The total gives you the overall COGS for that product in a given time period.

Want to see the formula in action? Check out our FIFO and LIFO calculator.

Some examples of FIFO and LIFO 

The best way to understand the FIFO and LIFO methods is to see them in practice. 

The FIFO formula

Let’s picture a florist using the FIFO method to manage inventory.

On Monday, the florist orders 20 roses for $10 each. They sell ten of them over the following two days.

They calculate the following on Wednesday evening to get their COGS:

10 x $10 = $100

On Thursday, they order another ten roses for $12 each. They sell 15 of them on Friday, leaving them with only five in stock.

The florist sits down to calculate their COGS for the five days. They assume they sold the oldest stock first and calculate:

10 x $10 = $100 (COGS for the older roses)

5 x $12 = $60 (COGS for the newer roses)

The florist can add up all these totals to get their overall COGS for roses from the week.

$100 + $100 + $60 = $260

The LIFO formula

Now let’s imagine a furniture store using the LIFO method:

In January, the store orders 10 chairs for $100 each. It sells four of them between then and the end of March.

The store calculates the COGS for this batch of chairs and gets:

4 x $100 = $400

In April, the store orders another 10 chairs but the purchase price has risen to $200. They sell a further two chairs in May.

As the store is using the LIFO method, we assume they’re selling the newest chairs first.

2 x $200 = $400

Again, the store can add up the totals for all five months to get their overall COGS for those five months.

$400 + $400 = $800

What if the store hadn’t used the LIFO method? They would’ve sold two chairs from the January order instead for $100 each. They would have calculated:

$400 + $200 = $600

As they did use the LIFO method, they’ve increased their COGS by $200. That means they’ve earned this much in tax deductions.

LIFO vs FIFO: Which should you use?

Let’s get the biggest deciding factor out of the way first: You can’t use the LIFO method if you’re outside the US as most countries have banned it.

If you do have the choice, here are your main considerations:

• Types of product: What’s your stock’s standard shelf life? LIFO only works if you don’t sell items at risk of expiring or going obsolete.

• Price trends: Are costs rising or falling? LIFO is mostly likely to get you significant tax benefits if there’s inflation.

• Tax implications: Do you have the accounting expertise to stay compliant? The IRS requires you to disclose the method you use and continue to apply it.

• Resources: Which method do you have the most support for? Maybe you have the labor needed to check and rotate stock for FIFO. Or perhaps you’re more confident in your ecommerce accounting skills to make the most of LIFO.

• Setup: You can only choose how to manage your inventory if you have full control over stock. That’s unlikely if you have a dropshipping business.

• Future plans: Are you planning to expand abroad? You may have to switch to FIFO outside of the US.

How to implement FIFO and LIFO for your business

There are a variety of ways to plan and execute the FIFO and LIFO methods. Here are some of the main ones:

Stock rotation

Organize your stock so the ones you need to sell first are most accessible, whether that’s the newest or the oldest.

In small stores, that means rotating your shelves as you receive deliveries. Staff should take out the old items and pack the new ones so nothing gets buried.

Warehouses are more complex. You need to batch the items and send newer products into deep storage while keeping the older ones ready at the front.

Regular audits

Get your team to frequently check your inventory to see whether everything’s still in order. This works best for FIFO. You can see if older products have gotten lost or hidden behind newer stock and whether they’re losing their freshness.

Barcodes and scanning

Make sure all your products have barcodes you can use to track and manage inventory. If you manufacture your own goods, you can find plenty of free tools to generate these. Morovia is a good example. Alternatively, many inventory management tools like Zoho and Fishbowl include this as a feature.

Automation

Use a combination of inventory management and accounting solutions to handle tasks and streamline operations.

Leading inventory management solutions can automatically monitor your inventory levels and send you notifications. You can get notifications if batches are fast approaching their sell-by date.

Accounting software like QuickBooks and Xero can auto-calculate your inventory value using the FIFO method. There’s little chance of errors, even if you’re selling a high volume of different goods.

Integrations and syncs

Connect all your software so you can easily track sales and orders across different channels. There’s less risk of losing track and selling from the wrong batches.

Popular ecommerce, accounting, and inventory tools should integrate with sales channels. You should be able to track stock whether you sell it from your dedicated website or other channels, like TikTok.

Ecommerce and accounting platforms can’t directly connect. That’s where integration tools like MyWorks come in. MyWorks lets you sync your ecommerce platform to QuickBooks or Xero so you can share order, sales, and inventory data in real time.

Track inventory no matter the method you use

Inventory management often comes down to what works for your online store. You can decide whether FIFO or LIFO is best for your size, structure, and industry.

While you can be flexible about some methods, others are non-negotiable. Everyone needs to track and record the products they sell. Losing sight of your inventory can lead to stock-outs and overstocking, which makes it much harder to turn a profit.

The secret is to work from the ground up. See which systems, strategies, and tools your business can’t go without and see how the FIFO and LIFO methods fit into that.