SKSP Insight: Inventory Control Methods

Businesses have several options when determining how to control their inventory. In this article, we’ll review some choices to help you determine what’s best for your business.

First In/First Out (FIFO)

In most retail environments, the most popular inventory method is the First-In, First-Out (FIFO) method. The reason is simply because this method is consistent with the way that inventory is physically managed in the business. It’s easy to understand and implement, and it reflects the most current market conditions as it assumes that the most recent purchases are sold first. Additionally, it matches the oldest, lower-cost inventory with revenue, which can help to minimize the impact of inflation on the cost of goods sold.

In times of rising prices however, it may not provide the most accurate picture of the cost of goods sold, as it doesn’t take into account the fluctuation in the cost of goods. The method also doesn’t allow matching current prices with current revenues, and this can lead to an overstatement in accounting records of the cost of goods sold. Finally, it can be difficult to implement in some industries, especially where items are not sold in the order they were purchased.

It’s important to note that, while FIFO is the most commonly used inventory method in retail, it may not be the best method for every retail business. Every retail business is unique and has its own specific needs, so it’s important to consult with an accountant or financial advisor to determine the best method for a specific business.

Last In/First Out (LIFO)

Another inventory control methods commonly used and accepted is Last-In, First-Out (LIFO). This is an inventory method where the last items purchased are assumed to be the first items sold. Commonly used in manufacturing and wholesale industries, this method matches the most recent, higher-cost inventory with revenue, which can help to minimize the impact of inflation on the cost of goods sold. It provides a more accurate picture of the cost of goods sold, as it takes into account the fluctuation in the cost of goods. Finally, it allows for the matching of current prices with current revenues.

There are some drawbacks to keep in mind, however. In times of falling prices, it may not provide the most accurate picture of the cost of goods sold, as it does not take into account the fluctuation in the cost of goods. And, it can be difficult to implement in some industries, where items are not sold in the order they were purchased. Finally, it’s simply not allowed in some countries, and it can create a difference in the tax base between financial statements and tax returns.

Weighted Average Cost (WAC)

Also commonly used in retail and manufacturing industries, this method is calculated by the averaging the cost of all items on hand and assigning it to the cost of each item sold. Useful when the cost of goods is fluctuating, it provides a more accurate picture of the cost of the inventory.

WAC provides a more accurate picture of the cost of goods sold, as it takes into account the fluctuation in the cost of goods. It’s easy understand and implement in the field, and it’s less sensitive to the order of purchase and sale.

However, in times of significant price fluctuation, it may not provide an accurate picture of the cost of goods sold. The method also doesn’t associate most recent inventory with revenue. And in industries where items have differing costs, it can be difficult to implement.

Specific Identification

Used primarily in high-value sales, or in businesses dealing items with unique characteristics, this method tracks each item individually and assigns the cost of the specific item to the revenue generated by the sale of that item.