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What Is Last In, First Out (LIFO)?

By Kristi Waterworth – Updated Feb 25, 2025 at 10:34 PM EST

Key Points

LIFO assumes the last item added to inventory is sold first, affecting reported profits.
LIFO can reduce taxable income by accounting for recent, higher costs.
Investors should examine LIFO use, as it may distort a company's financial health.

If you invest in companies that manufacture goods, or that maintain significant inventories, knowing just how the accountants deal with that inventory is vital. Last in, first out is one accounting method you should be familiar with.

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How does LIFO work?

Here's an example: Your company makes tires. Each tire is sold for $100. A week ago, tires cost you $30 to make, but this week, the price of rubber has gone way up, and they now cost you $50 to make. You have 100 tires in inventory, 40 from last week, and 60 from this week. Let's say you sell 80 of those tires to a distributor.

Under LIFO, you'd account for the cost of the tires you sold as follows. Since 60 were just produced, the cost of those will be figured at $50 each, totaling $3,000. The cost of the remaining 20 is calculated based on the former cost, $30, so they cost you $600. Your total cost for these tires is $3,600. You sold them for $8,000, so on paper, you profited $4,400.

With a FIFO calculation, those 80 tires would have cost you just $3,200. The oldest 40 were produced at $30 each, remember? That's $1,200 plus the second 40 that were produced at $50, totaling $2,000. Together, that's $3,200. Your profit on paper would then be $4,800.

Pros and cons of LIFO

LIFO is not practiced much outside of the United States because it can create an artificial tax advantage that's generally frowned upon in other countries. By valuing products based on the most recent cost, companies can reduce their incomes on paper since there's always a stream of new products being purchased or produced.

For the company, though, LIFO can be a lifeline, especially in difficult times like inflationary periods, but it can also paint a skewed picture of the company's income stream while reducing the taxes it pays. However, for investors and government agencies, the accounting can misrepresent financial aspects of the company, which isn't always great.

Why LIFO matters to investors

Investors who invest in companies that are primarily manufacturers or resellers must understand how their company handles their inventory accounting. Based on how the accounting is handled, the overall picture of the company's income and cash flow can be heavily skewed one way or another.

In a time of high inflation, LIFO will make a company look like it's not making as much money as it is, often with the goal of reducing the taxes it owes. This could cause a company's stock price to fall as investors lose faith in the company. This might be good for you, depending on what's actually happening with the core business. If all other things are well, you could find a great deal of value in a company that's practicing LIFO inventory accounting during a period of inflation.

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About the Author

Kristi Waterworth has been a contributing real estate and financial expert at The Motley Fool, covering real estate, investing, and personal finance topics, since 2020. Kristi has been interviewed by various TV media outlets and podcasts for her real estate investing expertise – from residential real estate to digital real estate and everything in between. Kristi’s journalist career spans over 25 years, and she has written about real estate investing, homeownership, and home construction specifically for the last decade. She was also previously a licensed Realtor and general building contractor before the Great Recession and housing market collapse. She holds a bachelor’s degree in American history from Columbia College in Missouri.

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