Managing inventory is important for any business. Choosing the right method can help improve profits and reduce taxes.
One useful method is LIFO (Last-In, First-Out). This means that sellers sell the most recent goods first. For small businesses in India, LIFO can be a great choice, especially when prices are rising.
Let’s break down the LIFO inventory method in simple terms and see how it can help your business grow.
LIFO is an inventory method where businesses sell their newest stock first. Imagine you have a store that sells bags of rice. If you buy 100 bags this week and 100 more next week, under LIFO, you will sell the bags you bought last (from this week) before the older ones.
How LIFO Works in Real Life
Think of a box of chocolates stacked one on top of another. If you always take chocolates from the top, the ones at the bottom stay longer. This is how LIFO works—you sell the latest products first, leaving older stock behind.
When the cost of goods goes up over time, businesses using the LIFO method sell their newest inventory first. This inventory is usually more expensive. This means that the cost of goods sold (COGS) is higher, and the taxable income is lower.
As a result, businesses pay less in taxes, helping them manage expenses more effectively during periods of inflation. This method ensures that inventory valuation reflects current market prices, making financial statements more relevant.
Saves Money on Taxes
Since LIFO increases the recorded cost of goods sold, it reduces the overall taxable income of a business. With lower taxable income, businesses pay less in taxes. This lets them reinvest the saved money into growth, operations, or new inventory.
This tax-saving benefit is especially helpful for businesses facing rising costs. It helps them manage their finances better.
Matches Current Market Costs
LIFO ensures that businesses record inventory costs in a way that aligns with current market trends. Using LIFO helps match costs with selling prices.
This is important because newer inventory costs more. It gives a clearer view of financial performance.
This helps businesses with changing prices. It stops old, cheaper inventory from affecting profit margins and financial reports.
Improves Cash Flow
By lowering taxes, businesses keep more cash. They can use this money for important operations, growth, or unexpected costs.
Better cash flow helps businesses pay suppliers on time. It also allows them to keep stock levels steady and invest in better services or products. The extra liquidity also provides a financial cushion during economic downturns or market uncertainties, keeping the business stable.
Useful for Businesses with Rising Costs
Industries where the cost of goods often goes up, like fuel, building materials, and food, gain the most from LIFO. This method helps businesses better reflect the true cost of replacing inventory, ensuring that pricing strategies remain competitive.
Using LIFO helps businesses avoid overestimating profits. This allows them to make better financial decisions. It also reduces the risk of financial mismanagement from old cost assumptions.
