📊 Financial Statement Analysis

FIFO vs LIFO — Inventory Valuation Methods Compared

FIFO vs LIFO inventory valuation explained. Impact on financial statements, COGS, taxes, and when to use each method. CFA Level 1 study guide.

Key Concepts

FIFO

First In, First Out. Ending inventory reflects recent costs (closer to replacement cost). In rising prices: higher income, higher inventory.

LIFO

Last In, First Out (US GAAP only). COGS reflects recent costs. In rising prices: lower income (tax savings), lower inventory, better cash flow.

Weighted Average

Average cost of all units available. Results fall between FIFO and LIFO.

LIFO Reserve

Difference between LIFO and FIFO inventory values. Disclosed by LIFO companies. Used to convert LIFO to FIFO for comparison.

Inventory Write-Down

IFRS: lower of cost or NRV (reversals allowed). US GAAP: lower of cost or market (no reversals).

Formulas

From this module

FIFO Inventory from LIFO

FIFO Inventory = LIFO Inventory + LIFO Reserve

Where: To make LIFO companies comparable to FIFO

FIFO COGS from LIFO

FIFO COGS = LIFO COGS - ΔLIFO Reserve

Where: Δ = change in LIFO reserve during period

Inventory Turnover

Inv Turnover = COGS / Average Inventory

Where: Higher = faster inventory movement

Days of Inventory

DOH = 365 / Inventory Turnover

Where: Days to sell inventory

Master Formula Sheet -- Financial Statement Analysis

Basic EPS

EPS = (NI - Pref Div) / Wtd Avg Shares

Earnings per common share

Diluted EPS

Diluted EPS = (NI - Pref Div + Convertible Interest) / (Shares + Dilutive Securities)

Treasury stock method for options

Current Ratio

Current Ratio = Current Assets / Current Liabilities

>1 indicates short-term solvency

Quick Ratio

Quick = (Cash + Receivables + ST Investments) / Current Liabilities

Excludes inventory

ROE

ROE = Net Income / Average Equity

Return to shareholders

DuPont (3-way)

ROE = (NI/Rev) × (Rev/Assets) × (Assets/Equity)

Profit margin × Turnover × Leverage

DuPont (5-way)

ROE = Tax Burden × Interest Burden × EBIT Margin × Turnover × Leverage

Extended decomposition

Inventory Turnover

Inv Turnover = COGS / Avg Inventory

Days = 365 / Turnover

DSO

DSO = 365 / Receivables Turnover

Receivables Turnover = Revenue / Avg AR

Debt-to-Equity

D/E = Total Debt / Total Equity

Financial leverage measure

Interest Coverage

Interest Coverage = EBIT / Interest Expense

Ability to service debt

CFO (Indirect)

CFO = NI + Non-cash charges ± WC changes

Start from net income, adjust

Free Cash Flow to Firm

FCFF = NI + NCC + Int(1-t) - FCInv - WCInv

Cash available to all capital providers

Free Cash Flow to Equity

FCFE = FCFF - Int(1-t) + Net Borrowing

Cash available to equity holders

Decision Frameworks

FIFO vs LIFO in rising prices?

Use when:

  • FIFO: higher income, higher BS inventory, higher taxes
  • LIFO: lower income, lower taxes (cash flow benefit), lower BS inventory

Avoid when:

  • Comparing a LIFO company to a FIFO company without adjusting

Test Your Understanding

In a period of rising prices, compared to FIFO, LIFO will report:

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