LIFO vs FIFO: how does each affect the financial statements when prices rise?

FIFO, first in first out, assumes the oldest inventory is sold first, so cost of goods sold uses older costs. LIFO, last in first out, assumes the newest inventory is sold first, so COGS uses the most recent costs.

When prices are rising, the newest costs are the highest. Under LIFO, COGS is higher, so gross profit, operating income and net income are lower than under FIFO. Because taxable income is lower, the company pays less tax, which means operating cash flow is higher under LIFO, even though reported profit is lower. On the balance sheet, LIFO leaves the older, cheaper layers in inventory, so the inventory balance is lower and can be well below current replacement cost. FIFO is the reverse: higher profit and inventory, higher taxes and lower cash flow.

Two practical points. LIFO is not permitted under IFRS, so it is mainly a US issue. And US companies using LIFO disclose a LIFO reserve, the difference between FIFO and LIFO inventory, which analysts use to put LIFO and FIFO companies on the same basis before comparing margins or multiples.