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FIFO vs LIFO: What You Need to Know to Choose the Right Method

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FIFO vs LIFO? We help you decide which accounting method is best for your business.

FIFO vs LIFO? We help you decide which accounting method is best for your business.

FIFO vs LIFO: the great business accounting debate.

At the end of your fiscal year, you’ll probably use one of these two accounting methods to value your inventory and report your profitability.

But they’re distinctly different and will produce very different results on your balance sheet.

To help you understand their differences, we’ll look at the advantages and disadvantages of LIFO and FIFO and give you our opinion on which one you should use in your business.

But before we do that, let’s define FIFO and LIFO.

What are FIFO and LIFO?

To determine your cost of goods sold at the end of the fiscal year, you need to determine the cost of all the products in your inventory.

That’s where FIFO and LIFO come in. Here’s what they stand for:

What is FIFO?

FIFO (first in, first out) is an inventory accounting method that says the first items in your inventory are the first ones that leave – meaning you get rid of your oldest inventory first.

What is LIFO?

LIFO (last in, first out) is an inventory accounting method that says the last items in your inventory are the first ones that leave – meaning you get rid of the newest inventory first.

FIFO vs LIFO: Advantages and Disadvantages

FIFO and LIFO are exact opposite accounting methods that deliver dramatically different results. Before you implement either of them, you should know the primary benefits and drawbacks of each method, which we detail below.

Primary Benefits of FIFO

  • FIFO is the most common accounting method.
  • There are no GAAP or IFRS restrictions on the use of FIFO.
  • FIFO increases the value of your inventory during inflation because your older items with a lower cost of goods are now a smaller percentage of your sales.
  • There’s less record-keeping since the oldest items in your inventory are continually used up.
  • If costs are decreasing, you pay fewer income taxes in the near-term since the first items sold are the most expensive.

Primary Drawback of FIFO

  • If costs are increasing, you pay a larger amount of income taxes in the near-term since the first items sold are the least expensive.

Primary Benefit of LIFO

  • If costs are increasing, you pay fewer income taxes in the near-term since the last items sold are the most expensive and you report the fewest profits.

Primary Drawbacks of LIFO

  • If costs are decreasing, you pay a larger amount of income taxes in the near-term because the last items sold are the least expensive which lowers your cost of goods sold leading to a report of higher profits.
  • The IFRS doesn’t allow the use of the LIFO method.
  • LIFO increases your layers of record-keeping since the oldest layers could remain in your system for years.

FIFO vs LIFO: Which Should You Use?

Well, there are obviously more benefits to using FIFO than LIFO, especially in the food industry.

If you handle food inventory management or operate any business with perishable items, then you pretty much have to use FIFO. Otherwise, you’ll end up with obsolete inventory that you’ll have to write-off as a loss.

With that said, LIFO is a great method for non-perishable homogeneous goods like stone or brick. So, if you get a fresh batch of items like these, you don’t need to rearrange your warehouse or rotate batches since they’ll be the first ones out anyway.

The bottom line:

Most businesses will benefit from FIFO while a select few businesses in specific industries will be better off using LIFO.

Regardless of which method you choose, you’ll need a powerful inventory management software that can automatically calculate your cost of goods sold in real-time.

And you probably want a software that automatically tracks fluctuations in prices for POs and suppliers, and helps you get the best deal on your goods.

Where can you find an inventory management software that delivers accurate reporting and so much more?

Right here at DEAR Inventory.

Use DEAR to Make Accounting Easier with FIFO

DEAR seamlessly Integrates with top-of-the-line accounting apps like Xero and Quickbooks, it syncs all of your invoices, bills, and payments to an app that can be accessed anywhere, and is built for true cost calculations and the FIFO method of accounting. We’ll give you financial data in real-time for smarter decision-making and higher profits.

Start your free 14-day trial of DEAR Inventory today!

Try DEAR for Free

No Credit Card Required

VAT in UAE 2018: Answers to The Most Important Questions

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A 5{cb377218d5687e54e8ee9149518f87201a393a7c1db5e8076e9d750029ec0dc3} value-added tax (VAT) will be effective in 2018 for the United Arab Emirates

A 5{cb377218d5687e54e8ee9149518f87201a393a7c1db5e8076e9d750029ec0dc3} value-added tax (VAT) will be effective in 2018 for the United Arab Emirates

The United Arab Emirates (UAE) Government is officially moving forward with a 5{cb377218d5687e54e8ee9149518f87201a393a7c1db5e8076e9d750029ec0dc3} value-added tax (VAT) that will take effect on January 1st, 2018 – and you need to prepare for it immediately.

Any business that’s required to register for the VAT in UAE must be registered before January 1st, 2018.

In the 3rd quarter of 2017, registration was open on a voluntary basis. Now that we’re in the 4th quarter of 2017, registration is mandatory.

If you don’t register your business before the end of the year, you’ll face penalties and fines as outlined in Section 25 of Federal Law No. 7.

To help you avoid the penalties and fees of UAE’s new tax law, we’ll answer the most pressing questions about the UAE VAT and show you exactly what it is, what it means for your business, and what you’ll need to do to remain compliant.

So let’s start with the most basic question:

What Is the UAE VAT Law and Why Is It Being Implemented?

The UAE VAT law is a general consumption tax which will apply to the majority of transactions of goods and services, including those bought from abroad. The tax will be set at 5{cb377218d5687e54e8ee9149518f87201a393a7c1db5e8076e9d750029ec0dc3} and will be implemented on January 1st, 2018.

In case you’re unfamiliar, here’s a quick overview of value-added taxes:

Value-added taxes are collected incrementally and are based on the value of the product or service at each stage of production and distribution.

So every stage of the product lifecycle will be taxed.

With a 5{cb377218d5687e54e8ee9149518f87201a393a7c1db5e8076e9d750029ec0dc3} VAT, if a supplier purchases a widget for $1 from a manufacturer, the manufacturer (the seller) will be required to charge an extra $.05 to the supplier (the buyer), and pay that $.05 to the Government.

The 5{cb377218d5687e54e8ee9149518f87201a393a7c1db5e8076e9d750029ec0dc3} tax will be added-on by every seller throughout the supply chain all the way to the final customer.

The UAE will be using this tax to curb their dependence on oil as a primary source of revenue and to provide citizens of the region with better public services such as hospitals, schools, and roads.

The UAE VAT is the second major tax being enacted after the Excise Tax took effect earlier this year.

With every new tax comes new regulations and burdens imposed on businesses covered by that tax.

Which brings us to the next question:

What will The UAE VAT Implementation Mean for Businesses?

The primary requirement for businesses in the UAE is recording all of their financial transactions and ensuring their financial records are accurate, up-to-date, and VAT compliant.

A business must register for VAT if their taxable supplies and imports exceed the mandatory registration threshold of AED 375,000 (AED is shorthand for UAE’s currency, Dirham).

However, you can voluntarily register your business for VAT if the taxable sales and imports within UAE exceed the voluntary registration threshold of AED 187,500.

Startups and small businesses can voluntarily register for VAT if their expenses exceed the voluntary registration threshold – a smart decision if they want to be eligible for tax credits.

You can register your business here. If you need help registering, the Federal Tax Authority (FTA) created this guide for you.

UAE’s Ministry of Finance clearly states that VAT-registered businesses must:

  • Charge VAT on taxable goods or services they supply
  • Keep a range of business records which will allow the government to check that they got things right
  • Report the amount of VAT they’ve charged and the amount of VAT they’ve paid to the government on a regular basis

The Ministry of Finance also stated that the following businesses will be charged a 0{cb377218d5687e54e8ee9149518f87201a393a7c1db5e8076e9d750029ec0dc3} VAT:

  • Exports of goods and services to outside the GCC
  • International transportation, and related supplies
  • Supplies of certain sea, air and land means of transportation (such as aircrafts and ships)
  • Certain investment grade precious metals (e.g., gold, silver, of 99{cb377218d5687e54e8ee9149518f87201a393a7c1db5e8076e9d750029ec0dc3} purity)
  • Newly constructed residential properties that are supplied for the first time within 3 years of their construction
  • Supply of certain education services, and supply of relevant goods and services
  • Supply of certain healthcare services, and supply of relevant goods and services

And these businesses are completely exempt from VAT:

  • Residential properties
  • Public transport
  • Undeveloped land
  • Life insurance
  • Certain financial services

The Ministry of Finance made it clear that businesses may reclaim any VAT they’ve paid on business-related goods or services, and may reclaim VAT if they’ve paid more VAT to the Government than they’ve charged their customers.

However, if you’ve charged more VAT than you’ve paid, you have to pay the difference to the government.

With all these responsibilities, the next obvious question is:

How Do Businesses Comply with VAT in UAE?

It should be stated that the burden of fulfilling your VAT requirements rests completely on your shoulders.

To comply with VAT in UAE, you’ll need to make the necessary changes to your financial management processes, your bookkeeping software, and your accounting staff to fulfill your role in allowing the FTA to understand your business activities and review your transactions.

Tax-paying Businesses must file VAT returns with the FTA on a regular basis (quarterly or for a shorter period, depending on the timeframe the FTA decides) within 28 days from the end of the tax period.

The most important records to keep (for a minimum of 5 years) to stay VAT compliant include the following:

Invoices

An invoice is a commercial document that records the products, quantities, and agreed prices for products or services between a buyer and seller.

As a VAT-registered business, you’ll be authorized and required to issue tax invoices in addition to normal invoices.

A VAT invoice must include the following information:

  • A unique sequential number
  • The date of issue
  • The supplier’s name, address and Tax Registration Number (TRN)
  • The customer’s name, address and Tax Registration Number (TRN)
  • Description of goods or services supplied
  • Total amount excluding VAT
  • Total VAT chargeable
  • Price and quantity of each item
  • Rate of discount per item
  • Rate of VAT charged per item – if an item is exempt or zero-rated, then mention there is no VAT on these items
  • Total amount including VAT

Credit Notes

A credit note is a commercial document that’s issued by a seller to a buyer when a product or service is refunded, when an invoice amount is overstated, or when a business refunds a buyer for any reason.

Debit Notes

A debit note is a commercial document issued by a buyer to a seller to request a credit note, or by a seller to a buyer to request additional payment if extra goods were delivered or goods already delivered were charged incorrectly.

What Tool Helps Businesses Stay VAT Compliant Automatically?

Staying VAT compliant is a difficult process, and it’s made worse if you’re using accounting software that isn’t designed to work with VAT.

Plus, if you’re managing your inventory and fulfilling your orders and doing your accounting in separate programs with no integration between them – you’ll increase your risk of errors and tax penalties.

That’s why we believe the most important tool you can use to stay VAT compliant is cloud-based inventory management and accounting software that does the hard work for you.

  • Software that has built-in advanced bookkeeping features to help ensure your accounting meets all of the UAE VAT requirements.
  • Software that customizes your invoices to automatically include the 5{cb377218d5687e54e8ee9149518f87201a393a7c1db5e8076e9d750029ec0dc3} VAT (and any other taxes you have to calculate).
  • Software that lets you keep track of sales tax across all your sales channels (from ecommerce platforms to retail stores).

And software that does all of this while tracking your inventory in real-time, fulfilling your orders automatically, and integrating seamlessly with all of your business apps.

Where will you find such a powerful software ready-made for the VAT in UAE?

Right here at DEAR Systems.

Inventory Software That Keeps You VAT Compliant with Ease

Our cloud-based inventory management system integrates with leading accounting apps such as Xero and Quickbooks for streamlined accounting that’s VAT compliant while storing all of your invoices for simplified bookkeeping. The best part is, you’ll stay VAT compliant while enhancing your inventory management at the same time.

Start your free 14-day trial of DEAR Inventory today!

Try DEAR for Free

No Credit Card Required

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What is Working Capital and Why Does it Matter?

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Find the right level of working capital to grow a healthy business

Find the right level of working capital to grow a healthy business

Working Capital is an important financial metric for understanding your company’s operating liquidity (the ability to convert your assets into cash for the purpose of paying the bills). Knowing your amount of working capital can also guide your inventory strategies, leading to smarter buying decisions.

By the book, the definition of working capital is:

Working Capital = Current Assets – Current Liabilities 

In other words, it’s the cash you have left over once all payments due to you are collected and your bills are paid.

If your company maintains an inventory of goods that you sell to your customers, the formula can be expanded to:

Inventory Value (value of items for sale and items used to make goods for sale)

+ Receivables from Customers (cash owed to company for sales)

+ Rebates from Suppliers (Discounts for buying a certain value, quantity, or within a certain timeframe)

– Payables to Suppliers (cost of inventory)

= Working Capital.

What’s considered a healthy working capital varies from industry to industry – but in theory it should be as low as possible.

A low working capital is a strong indicator that your company is finding the right balance between what you have on your shelves, the revenue you are generating, the investments you are making in your future, and the debts you owe.

A high working capital can be a sign your business is booming, but it can also mean you’re missing investment and growth opportunities.

Another Insightful Approach

In the business world, working capital is usually measured not by the cash figure of assets minus liabilaties, but by what’s known as your current ratio, which is:

Current Ratio = Current Assets / Current Liabilities 

According to Investopedia, your business should aim for a current ratio between 2.0 to 1.2, but this varies by industry; here are some average current ratios for industries you’re likely in, according to CSIMarket:

  • Internet, Mail Order, & Online Shops: 1.12
  • Wholesale: 1.29
  • Food Processing: 1.26
  • Miscellaneous Manufacturing: 1.55

A ratio higher than 2 is a sign that you’re not properly using your funds – either in the form of carrying too much inventory or not capitalizing on extra cash by investing in growing your business, while a ratio lower than 2 may make it difficult to find the cash you’ll need to pay your suppliers and other debts.

The metric changes as quickly as you make sales, pay suppliers, or increase your inventory – but by understanding how the decisions you make affect it, you can take control of your working capital instead of letting it control you.

Here are some aspects of your operations to consider as you create your working capital management strategy:

Turn Down Supplier Discounts

Just say no (sometimes)! Avoid the temptation to take advantage of supplier discounts when they mean ordering more inventory than you need right now.

Sure, you could buy three times the materials to reduce your per item cost by 75{cb377218d5687e54e8ee9149518f87201a393a7c1db5e8076e9d750029ec0dc3}. But unless you can actually sell that inventory, you risk filling your shelves with stuff that can quickly become obsolete, broken, or buried.

By collecting data to understand your what your customers want and when, you can better decide when it’s the right time to take advantage of these discounts.

Achieve Negative Working Capital

There are two ways to look at negative working capital – one way is a signal of financial distress for a company indicating you have spent more money than you have.

A more positive definition involves a strategy that requires careful thought and planning.

By setting terms of payment with your suppliers that give you enough time to collect from your customers before you pay for the raw materials of the items you sold – you are in essence borrowing cash from your suppliers to free up more money for your day to day operations.

This strategy requires an in-depth understanding of your customer demand cycles to ensure its possible to sell all your inventory and collect from your customers prior to your invoice due dates.

Negotiate your payment terms with your own billing cycle in mind. Be sure to give yourself an overlap period where you have cash payments in the bank, but no invoices due for the products and materials you just sold.

For example, let’s say you made $100 in sales for product X and have collected all payments due from your customers.

You owe your suppliers $50 for the raw goods you used to make product X, but the invoice isn’t due for another two weeks.

Because working capital only factors in supplier payments that are currently due, your working capital is a $100 ahead instead of only $50 – which is what it would be if you had to pay your supplier at the same time you collected payment.

Maintaining a negative working capital balance frees up cash to take advantage of opportunities to spend money on growing your business and reducing debts.

Control Inventory Levels

Inventory reduction plays a major role in achieving an ideal working capital – the less inventory on hand, the less you owe to suppliers, tipping your working capital in your favor.

Take control of your inventory levels by putting your sales and purchasing history data to work helping you predict the optimal levels of inventory necessary to operate.

The goal is to use that data to find the right balance between demand, production, and ordering raw materials or stock.

Order too much and you’ve tied up cash resources in product or materials that aren’t making you money. Purchase too little and now you run the risk of losing sales to your competitors who do have the product available for sale.

If this all seems like an elaborate guessing game, you’re not alone. Learn more about inventory reduction in our earlier post. From “lead times” to “just-in-time,” it covers the basics you need to know to get started.

Find the Balance, Achieve Results

Businesses of any size can find a healthy balance of inventory, taking advantage of supplier discounts, and payment cycles by leveraging inventory management software thanks to cloud-based tools like DEAR Inventory.

 

Want Better Data to Make Better Decisions?

Experience the tracking and reporting power of modern cloud-based inventory management software by starting your free 14-day trial of DEAR Inventory today!

Try DEAR for Free

No Credit Card Required

 

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