======LIFO vs. FIFO======
[[LIFO (Last-In, First-Out)]] and [[FIFO (First-In, First-Out)]] are two primary methods companies use for [[Inventory]] accounting. They are essentially rules that dictate how to calculate the cost of goods a company sells. Imagine a shelf of identical products bought at different times for different prices. When a product is sold, which cost do you use to calculate your profit? FIFO assumes the **first** items purchased are the **first** ones sold, just like a grocer would sell older milk before it expires. LIFO, conversely, assumes the **last** items purchased are the **first** ones sold, as if the newest stock were placed at the front of the shelf for customers to grab first. This choice is purely an accounting one and doesn't have to match the actual physical movement of goods. The method a company chooses can have a significant impact on its financial statements, particularly on reported profits and taxes.
===== An Inventory Tale: The Corner Gadget Shop =====
To understand the real-world difference, let's visit a small shop that sells a popular widget. The owner, Bob, wants to track his profitability.
==== FIFO: First Come, First Served ====
Under FIFO, Bob assumes he sells his oldest widgets first.
  * **January:** Bob buys 10 widgets for $10 each.
  * **February:** Prices go up! He buys 10 more widgets for $12 each.
  * **March:** He sells a single widget for $20.
Using FIFO, Bob's [[Cost of Goods Sold (COGS)]] is $10 (the cost of his oldest widget). His [[Gross Profit]] on the sale is $20 (revenue) - $10 (COGS) = **$10**. This method is intuitive and matches the logical flow of most businesses trying to sell older stock before it becomes obsolete.
==== LIFO: The New Kid on the Block Goes First ====
Now, let's rewind and say Bob's accountant uses LIFO. He assumes the newest widgets are sold first.
  * **January:** Buys 10 widgets for $10 each.
  * **February:** Buys 10 more widgets for $12 each.
  * **March:** Sells one widget for $20.
Using LIFO, Bob's COGS is $12 (the cost of his //newest// widget). His Gross Profit is now $20 (revenue) - $12 (COGS) = **$8**. Notice how the reported profit is lower, even though the business operations were identical.
===== Why Should a Value Investor Care? =====
This isn't just an accountant's headache; it's a critical piece of information for an investor. The choice between LIFO and FIFO directly affects a company's reported [[Net Income]] and, therefore, metrics like [[Earnings Per Share (EPS)]].
==== The Inflation Game ====
The real drama happens during periods of changing prices, especially [[Inflation]].
  * **In a rising price environment (inflation):**
    - **LIFO** matches the most recent (higher) costs against current revenue. This results in a //lower// reported profit. While that might sound bad, it has two benefits for the sharp investor: it reduces the company's tax bill, and it can present a more conservative and realistic picture of a company's sustainable earning power.
    - **FIFO** matches older (lower) costs against current revenue. This creates //higher// reported profits, sometimes called "phantom profits," which can make a company look more profitable than it truly is on an ongoing basis. It also leads to a higher tax bill.
As a value investor, you're looking for the true, underlying economic reality of a business. A company using LIFO in an inflationary period might have its earnings understated, potentially making it look artificially cheaper than its FIFO-using competitors.
==== The LIFO Reserve: A Secret Decoder Ring ====
How can you compare a LIFO company to a FIFO company? Look for the [[LIFO Reserve]] in the footnotes of the financial statements. This figure represents the amount by which the LIFO inventory is "understated" compared to what its value would be under FIFO.
**Inventory Value (FIFO) = Inventory Value (LIFO) + LIFO Reserve**
By adding the LIFO Reserve back to the LIFO inventory and adjusting the COGS accordingly, a clever investor can convert a company's financial statements from LIFO to FIFO, allowing for a true apples-to-apples comparison.
===== A Tale of Two Standards =====
One final, crucial point for global investors: the accounting world is divided on this issue.
  * **[[U.S. Generally Accepted Accounting Principles (U.S. GAAP)]]:** Permitted in the United States, LIFO is often chosen for its tax advantages during inflationary times.
  * **[[International Financial Reporting Standards (IFRS)]]:** Banned. Regulators in Europe and other regions that follow IFRS believe LIFO can distort earnings and is a poor representation of a company's inventory flow.
This means if you're comparing a U.S. company to a European one, you absolutely must be aware of which inventory method each is using and adjust your analysis accordingly.