Inventory turnover ratio for FIFO vs. LIFO
When we discuss LIFO and FIFO, we should also talk about the inventory turnover ratio.
The inventory turnover ratio is a crucial metric for measuring business performance, and the method you use to value inventory (FIFO or LIFO) can significantly impact your ratio.
Theinventory turnover ratiois calculated by dividing the cost of goods sold by the average inventory. The average inventory is calculated by adding the beginning stock to the ending inventory and dividing it in two.
An example of calculating the inventory turnover ratio would look like this:
Let’s say your cost of goods sold for the year is $100,000, your beginning inventory is $10,000, and your ending stock is $15,000.
Your average inventory would be:
$12,500 ($10,000 + $15,000)/2
Your inventory turnover ratio would be: 8 ($100,000/$12,500)
Let’s say you use LIFO instead of FIFO to value your inventory.
If we assume all other factors stay the same, your cost of goods sold would increase because the most recent, and therefore most expensive, items are included in the calculation. This change would result in a lower inventory turnover ratio.
In this example, if your cost of goods sold increased to $105,000, your inventory turnover ratio would be:
8.4 ($105,000/$12,500)
As you can see, the inventory valuation method you choose can significantly impact your inventory turnover ratio.
