Inventory control is vital in a growing and profitable organization. In general, there are two different ways to control inventory, through LIFO or FIFO. LIFO stands for Last In First Out, meaning that the last inventory in is the last inventory out, and FIFO stands for First In First Out, which means the first inventory in is the first inventory out. The type of inventory control used depends on the business model and the nature of goods sold.
Create a list of actual inventory for at least six months of your business' operations. If your business is a startup, project the first six months of your business. Start with a forecast of weekly expenses, then monthly and so on.
Sort the list of inventory by date purchased. Assume that prices in the general market rise over time. This is the general assumption taken by the IRS and other accounting boards.
Determine how inventory will be used in the business. Inventory with an expiration date, like produce, is usually calculated under the FIFO methodology. Inventory under the LIFO method may not have any expiration and can usually be sold for components. FIFO ensures that the oldest inventory is used first and is helpful for those businesses with high inventory turnover and low profit margins. FIFO is also good for businesses that aren't concerned about the order of items as much as the quality of the items being sold.
Understand how net income and the balance sheet are affected. LIFO results in a lower net income, and FIFO results in a higher net income. Likewise, LIFO also results in lower asset values on the balance sheet.