In the world of logistics and inventory management, it is essential to keep a grip on the order in which goods are stored and delivered. One of the most widely used methods for this is the LIFO method, or Last In, First Out. This method stipulates that the last incoming products leave the warehouse first. This affects both operational processes and accounting within organisations.
For logistics professionals - from warehouse workers to supply chain managers - it is important to understand when and why LIFO is beneficial. In this article, we dive into the origins of the LIFO model, explain how it works, compare it to the FIFO method and provide a practical example to bring the concept to life.
How did LIFO originate?
The origins of the LIFO method lie in the accounting world of the early 20th century. During periods of inflation, companies looked for methods to reduce their tax burden by minimising their profits on paper. LIFO offered a solution: by putting the newest, often most expensive, inventory costs on the books first, profits remained lower and with them the tax payable.
In the logistics sector, LIFO was gradually also applied as a practical method for inventory management, especially in situations where physical access to products is not naturally set up on FIFO. Think of storage systems such as stacking racks or containers in which new products are easier to access than older ones.
Although LIFO is allowed for accounting purposes in some countries, such as the United States (under GAAP rules), it is not recognised as a valid inventory valuation method in Europe under IFRS. Nevertheless, within logistics and internal cost allocation, it remains a relevant way to manage inventory flows - especially in industries where inventory rotation need not be strictly chronological.
3 advantages of the LIFO method
For logistics and financial processes, the LIFO method offers several advantages, depending on the context in which it is applied. The main ones are:
- Cost savings when prices rise
When raw materials or goods purchase prices rise, LIFO ensures that the newest - and therefore more expensive - stock is recorded as sold first. This leads to a higher cost of goods sold (COGS) and thus lower profits. The result: a possible short-term tax advantage.
- Efficiency in specific storage structures
In certain warehouse layouts, such as bulk storage or containers, it is more convenient to grab the newest products first. LIFO fits well into these scenarios because it matches the physical reality of the warehouse process. As a result, less movement of goods is required, saving time and labour.
- Lower accounting inventory value
As the older, cheaper products stay in the warehouse longer, the inventory value on paper becomes lower. This can help in attracting investors or in certain financial analyses, where a lower asset value is seen as a positive.
How does it differ from the FIFO method?
FIFO stands for First In, First Out, which means that the products that come in first are also the first to leave the warehouse. Unlike LIFO (Last In, First Out), FIFO ensures that older stock is used or sold first.
➤ Inventory turnover
- FIFO: Provides a natural rotation of products, ideal for perishable goods such as food, pharmaceuticals or fashion items.
- LIFO: Leave older stock, which is acceptable for products with no expiry date or aging risk.
➤ Accounting impact
- FIFO: With rising prices, FIFO leads to a lower cost of goods sold and therefore a higher profit - which means more tax.
- LIFO: In contrast, LIFO shows higher costs and therefore lower profits, which is beneficial for reducing the tax burden.
➤ Logistic application
- FIFO is often supported by automated systems and rack configurations that facilitate rotation (such as flow racks or pallet live systems).
- LIFO works better in environments where access to the oldest stock is difficult or unnecessary, such as bulk storage or return logistics.
In short: the choice between FIFO and LIFO depends heavily on the type of product, the physical layout of the warehouse and the company's strategic goals.
Example of the LIFO method
Imagine a warehouse that stores building materials, such as bags of cement. These are stacked on pallets, and each new delivery is placed on top of the stack. When an order comes in, the warehouse worker simply grabs the topmost bags - the ones that came in last. This is a classic example of LIFO in action.
Case study:
A construction wholesaler receives three shipments of cement in one week:
- Monday: 100 bags at €5
- Wednesday: 100 bags at €6
- Friday: 100 bags at €7
On a Friday, the warehouse sells 100 bags. According to the LIFO method, Friday's bags are then delivered first - i.e. at a cost of €7 per bag. Accounting-wise, this higher cost is booked, which lowers profits but can also reduce the tax burden.
For the warehouse worker, it means less physical effort: the most recently stacked products are immediately accessible. The system fits perfectly in storage locations where products have a long shelf life and rotation is of minor importance.
