Accounting Method

FIFO vs LIFO: Which Inventory Method Maximizes Profit for Makers

You bought beads in January for $100, then June for $120 (prices rose). You now sell 50 beads. Did you sell the January batch (lower cost) or June batch (higher cost)? FIFO and LIFO determine the answer—and directly impact your taxes, cash flow, and reported profit. This guide teaches you to choose the method that maximizes your financial health.

Why This Matters

Two makers with identical sales, materials, and production. One uses FIFO, the other LIFO. After taxes, one has $3,400 more profit. Same business. Different accounting method. That's not a coincidence—it's the power of inventory accounting strategy.

FIFO: First-In, First-Out

FIFO Assumption:

The first materials you bought are the first materials you sell.

How FIFO Works

Purchase Date	Quantity	Cost/Unit	Total
January (purchased)	100 beads	$1.00	$100
June (purchased)	100 beads	$1.20	$120
You sell 50 beads (FIFO)	50 beads	$1.00 each	$50 COGS
Remaining Inventory	150 beads		$170

Key point: FIFO "consumes" the cheapest inventory first. Lower COGS = Higher profit = Higher taxes.

FIFO Impact:

Lower COGS when inflation is rising (sell cheap inventory first)
Higher reported profit (more attractive for loans, investors)
Higher tax bill (profit = taxes)
Better cash flow appearance (ending inventory valued at recent high prices)

LIFO: Last-In, First-Out

LIFO Assumption:

The most recent materials you bought are the first materials you sell.

How LIFO Works

Purchase Date	Quantity	Cost/Unit	Total
January (purchased)	100 beads	$1.00	$100
June (purchased)	100 beads	$1.20	$120
You sell 50 beads (LIFO)	50 beads	$1.20 each	$60 COGS
Remaining Inventory	150 beads		$160

Key point: LIFO "consumes" the most expensive inventory first. Higher COGS = Lower profit = Lower taxes.

LIFO Impact:

Higher COGS when inflation is rising (sell expensive inventory first)
Lower reported profit (less attractive for loans, investors)
Lower tax bill (less profit = less tax)
More cash in your pocket (tax savings)

Note: LIFO is not allowed under international accounting standards (IFRS) and is increasingly restricted in the US. Check with your accountant before choosing LIFO.

The Real-World Impact

Scenario: Jewelry maker, selling 1,000 pieces/year

Year 1 Costs:

• Q1: Bought 300 units @ $10 = $3,000
• Q3: Bought 400 units @ $12 = $4,800
• Sold 1,000 units @ $45 = $45,000 revenue

FIFO Method:

• COGS: (300 × $10) + (700 × $12) = $11,400
• Gross Profit: $45,000 - $11,400 = $33,600
• Tax (30%): $10,080
• After-tax profit: $23,520

LIFO Method:

• COGS: (400 × $12) + (600 × $10) = $10,800
• Gross Profit: $45,000 - $10,800 = $34,200
• Tax (30%): $10,260
• After-tax profit: $23,940

LIFO advantage: $420 more tax savings per year. Over 5 years: $2,100 cash kept.

Which Method Should You Use?

Use FIFO if:

Your costs are stable or declining. You want to show maximum profit (for loans, investors). You're filing taxes internationally (IFRS requires FIFO or weighted average).

Use LIFO if:

Costs are rising (inflation). You want to minimize taxes and keep more cash. You're filing in the US (LIFO still allowed) and have an accountant who supports it.

Action:

Talk to your accountant. The choice is permanent (changing requires IRS approval). Make it thoughtfully based on your cost trends and business goals.

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