How do you adapt your inventory valuation method to changing market conditions or customer demand?

1 FIFO vs LIFO

FIFO (first-in, first-out) and LIFO (last-in, first-out) are two of the most widely used inventory valuation methods. FIFO assumes that you sell the oldest items first, while LIFO assumes that you sell the newest items first. FIFO tends to reflect the current market value of your inventory, while LIFO tends to reduce your taxable income by matching your cost of goods sold with the highest prices. However, both methods have their drawbacks. FIFO can inflate your profits and taxes when prices rise, while LIFO can distort your inventory value and create stock obsolescence when prices fall. To adapt to changing market conditions, you may want to switch between FIFO and LIFO depending on the price trends and the nature of your products.

2 Weighted Average Cost

Another common inventory valuation method is the weighted average cost (WAC), which calculates the average cost of your inventory by dividing the total cost of goods available for sale by the total number of units available. WAC smoothes out the fluctuations in inventory costs and prices, and reduces the complexity of tracking individual items. However, WAC can also obscure the true profitability and value of your inventory, and make it harder to identify slow-moving or obsolete items. To adapt to changing customer demand, you may want to use WAC for homogeneous or low-value products, and use a more specific method for heterogeneous or high-value products.

3 Specific Identification

Specific identification is an inventory valuation method that assigns a specific cost to each individual item in your inventory. This method is usually used for unique or customized products, such as jewelry, art, or furniture. Specific identification gives you the most accurate and detailed information about your inventory value and profitability, and allows you to track the history and location of each item. However, specific identification can also be costly, time-consuming, and prone to errors or fraud. To adapt to changing customer demand, you may want to use specific identification for products that have a high demand variability, a long lead time, or a high customer satisfaction impact.

4 Standard Cost

Standard cost is an inventory valuation method that assigns a predetermined or estimated cost to each unit of inventory, based on historical data, industry benchmarks, or engineering estimates. This method is usually used for mass-produced or standardized products, such as electronics, clothing, or food. Standard cost simplifies your inventory accounting and budgeting, and helps you identify variances between actual and expected costs. However, standard cost can also be inaccurate, outdated, or unrealistic, and fail to capture the changes in market conditions or customer demand. To adapt to changing market conditions, you may want to update your standard costs regularly, and use variance analysis to monitor and adjust your performance.