How do you use FIFO?
Let’s say a business buys lumber every month over three months. In the first month, lumber costs $300 per 1,000 board feet; in the second month, it costs $400 per 1,000 board feet; and in the third month, it costs $500 per 1,000 board feet.
If you bought 10,000 board feet in each month and used 15,000 board feet in the quarter, then you would account for that using the FIFO method as 10,000 board feet at a cost of $300 per 1,000 board feet and 5,000 board feet at a cost of $400, or a total of $5,000.
Using the LIFO method, the cost of goods sold for the quarter would be $7,000, or $5,000 for the first 10,000 board feet, and the same $2,000 for the remaining 500 board feet.
The FIFO method would result in $2,000 less in cost of goods sold and $2,000 more in profit than the LIFO method, even though the business performed the same activities.
Understanding FIFO is helpful if you’re running a business, if you’re an investor, or if you’re interested in knowing more about how business accounting works. There are other types of accounting methods, including specific identification, which requires businesses to track each individual unit that’s sold, but FIFO is the most common method for financial reporting because it’s straightforward and intuitive.
Whether you’re investing in a bull market or not, understanding FIFO is one of the many steps you can take to learn more about the businesses you’re investing in.