FIFO, FEFO, LIFO, and LEFO are four different inventory management methods used by businesses to manage the flow and valuation of their stock. Each method follows a specific principle for determining the order in which items are consumed or sold and how their costs are assigned. Let's break down each one:
FIFO (First-In-First-Out): FIFO is an inventory management method that assumes the first items purchased or produced are the first ones to be sold or consumed. In other words, the oldest items in stock are sold first, while the most recent ones remain in inventory. This method is often used for perishable goods or items with expiration dates. FIFO ensures that the oldest and potentially less fresh or valuable items are used first, reducing the risk of waste or obsolescence.
FEFO (First-Expired-First-Out): FEFO is a variation of the FIFO method, primarily used for managing perishable goods or products with strict expiration dates. It follows the same principle as FIFO but emphasizes the priority of items based on their expiration date. The oldest items with the closest expiration dates are sold or used first, reducing the risk of selling expired products.
LIFO (Last-In-First-Out): LIFO is an inventory management method that assumes the last items purchased or produced are the first ones to be sold or consumed. In other words, the most recent items in stock are sold first, while the oldest ones remain in inventory. LIFO is often used to manage inventory costs during periods of inflation since the most recent, and potentially more expensive, items are recognized as sold first, resulting in lower cost of goods sold and higher apparent profits. However, LIFO can lead to inventory obsolescence and may not reflect the actual physical flow of goods.
LEFO (Last-Expired-First-Out): LEFO is a variation of the LIFO method, which combines the principles of LIFO and FEFO. It is used for managing perishable goods with expiration dates in situations where the inventory costs are crucial during periods of inflation. LEFO assumes that the most recent items with the closest expiration dates are sold or used first, providing some protection against selling expired products while still benefiting from LIFO's cost management advantages during inflationary periods.
Each of these inventory management methods has its advantages and disadvantages, and businesses choose the one that aligns best with their specific needs, the nature of their products, and prevailing economic conditions. The choice of inventory method can significantly impact financial reporting and tax implications, so it's essential for businesses to carefully consider which method suits their operations best and share that information with their 3PL. Understanding this concept up front in the relationship will help set the program up for success!