If you don't have a background in inventory management or accounting, odds are that you're not quite sure what inventory costing methods are or what the differences between them are. It can also get confusing with so many acronyms thrown about. LIFO, FIFO, DEVO, YOLO, or whatever they are.
We'll help you understand what the two main methods are, how they're different, and the pros and cons of each.
FIFO Inventory Method
First-in first-out (FIFO) is an inventory costing method where the goods you purchase first are the goods you use and sell first. This method is designed for businesses where inventory is perishable or has a short demand cycle. Most restaurants and bars use this inventory method.
LIFO Inventory Method
Last-in first-out (LIFO) is an inventory costing method where your most recently purchased goods are the goods you use and sell first. This method is designed for businesses where prices of goods increase often so the newer, more expensive goods are used first. It is very unlikely to see a bar or restaurant using this method, but it has been done.
Inventory Valuation Methods for Restaurants
LIFO and FIFO are both accepted inventory valuation methods for restaurants and bars, though FIFO is far more common. It's your business, so you can choose what type of inventory valuation you use. We'll run you through the pros and cons of each to help you make the right decision for your own restaurant or bar.
Inventory Costing Methods: Pros, Cons & Summary
FIFO and LIFO have different purposes and yield different results. Here are the main things you need to know about each.
Pros of FIFO:
- Good for perishable items. Since you're in the restaurant or bar inventory this point should call out to you. You can limit waste and shrinkage by using your products before expiration. Even liquor goes bad, so you need to sell it within a certain time.
- Yields a higher net income. As you sell the older products first, you won't have high overhead costs of storage. You also won't deal with much depreciation since you sell the products before they lose too much value and maximize bar profitability. Wine is the only product you have that may appreciate in value depending on vintage.
- Matches your flow of goods. It's harder to get confused about inventory levels when using the FIFO method. Every item comes in and goes out in the same order. You have a better understanding of your inventory and can use this when making decisions.
- Everyone's using it. This may sound like it's not important, but there's a reason nearly every restaurant does the same thing. FIFO just makes sense for the industry. You can always find accountants or finance people to work for your business without the need for a lot of training.
Cons of FIFO:
- You pay higher taxes. Prices generally increase. This means the earliest purchased products had the lowest cost and will have a higher margin when you sell them. This also gives you a higher taxable income. More money in your pockets always means more money goes to the government.
- Your revenue and cost don't match. Products sold are accounted for at prices that are obsolete but revenue is calculated at current levels. This makes accounting slightly more complicated and the SEC's Generally Accepted Accounting Principles (GAAP) don't particularly like it.
Pros of LIFO:
- Good for non-perishable items. Items like restaurant-branded t-shirts and mugs are what come to mind here. Since they don't diminish in value or expire, these items can sit in storage for some time. Newer items may also be more desirable by customers.
- Good when prices are volatile. If prices often fluctuate, selling the newer items first may be desirable. This will limit losses and ensure a return on your goods.
- You pay lower taxes. Adherents to LIFO sell their most recently purchased, and therefore highest priced, products first. This results in lower profits and lower taxable income.
Cons of LIFO:
- Banned or restricted by certain organizations. The International Financial Reporting Standards (IFRS) bans the use of LIFO accounting due to its use by unscrupulous businesses to distort reported numbers. The GAAP also restricts its use for the same reason.
- Leads to lower income. Since products sold under LIFO have the highest cost of goods sold, the profit margin and income for the business is lower.
We highly recommend you go for a FIFO approach to your inventory costing. It makes the most sense for a bar or restaurant. It is also more accepted by the accounting world-at-large and leads to a higher income for your bar.
Control Your Inventory, Control Your Profit
If you haven't figured it out by now, inventory management is an integral part of restaurant and bar profitability. Knowing how to calculate inventory usage, track variance, and adjust your plans based on inventory is vital. It will give you the tools you need to achieve greater results.
Once you pick the correct inventory costing method for your business, you should look into bar inventory software to help automate the process and give you insight to drive revenue. BinWise can take your bar or restaurant to the next level.