- Simplicity: FIFO is a relatively simple inventory costing method to implement and maintain. It does not require any complex calculations or sophisticated inventory tracking systems.
- Accuracy: FIFO provides a more accurate representation of the cost of goods sold when prices are rising. This is because the cost of the most recently purchased inventory is used to value the goods sold, which more closely approximates the actual cost incurred by the company.
- Tax benefits: FIFO can result in lower taxes in periods of rising prices. This is because the cost of goods sold is higher under FIFO, which reduces the company's taxable income.
- Better cash flow management: FIFO can help companies manage their cash flow more effectively by ensuring that the oldest inventory is sold first. This means that the company will have a faster turnover of inventory and will generate cash more quickly.
Disadvantages of FIFO:
- Overstatement of inventory value: FIFO can lead to an overstatement of the value of inventory when prices are falling. This is because the cost of the oldest inventory, which is still in inventory, is higher than the current market value.
- Potential for stockouts: FIFO can increase the risk of stockouts when demand is high. This is because the oldest inventory is sold first, which means that the company may run out of inventory if there is a sudden increase in demand.
- Difficulty in tracking inventory: FIFO can be difficult to track when there is a high volume of inventory transactions. This is because the company needs to keep track of the cost of each individual item of inventory in order to determine the cost of goods sold.
- Less accurate representation of current costs: FIFO does not provide an accurate representation of the current cost of goods sold when prices are falling. This is because the cost of the most recently purchased inventory is used to value the goods sold, which may be higher than the current market value.