Jack TenneyExtra Point

by Jack Tenney, Publisher

January 2002

FIFO FI Fum

Well, another physical year is upon us. It's high time to review some of the financial jargon that helps us Business People figure fiscal figures in our quest to make a dollar out of 99 cents, put food on the table, shoes on the baby, meet the payroll and be open for business bright and early Monday morning.

Inventory valuations are as good a place to begin as any. Everyone knows that retailers buy items for resale at a lower price than the price they wish to charge their customers. During periods of price fluctuations, mark- ups, mark-downs, close-outs and the like, the method used to value unsold inventory items is critical to the determination of profitability for an enterprise.

The identified cost method is simplest. It is appropriate for resellers of unique items such as antiques. The acquisition cost of each item is recorded, and the total value of the inventory for accounting purposes is merely the sum of the costs of all the goods remaining in inventory.

Retailers offering rack goods (clothing and the like) prefer an inventory method aptly called the retail inventory method. There the inventory is valued at its selling prices, totaled and then discounted by a standard markup. For instance, if a retailer has 1,000 items that have a total retail value of $50,000 and the standard markup is 100 percent (AKA keystone), then the inventory is valued at $25,000. (Most investors have relearned recently that, if a stock price has fallen 50 percent, it must rise 100 percent to break even.)

Resellers of dated merchandise like doughnuts find FIFO first-in, first-out the best way to track profitability and value inventory (sometimes a mutually exclusive exercise). FIFO is probably a good way to value computer chips that have a history of continual price drops. It is most conservative then to measure profitability against the higher costs of the earlier buys while valuing the inventory on hand at its latest and lower costs.

The coal-pile theory of inventory valuation is favored by many resellers of commodities. The theory is based on the fact that a coal dealer is unlikely to sell all its coal. Instead it keeps buying coal that is added to its pile, which is reduced when it resells the coal. Therefore, it is most reasonable to measure the profitability of each sale by deducing the latest purchase cost from the selling price. This method is known as the LIFO last-in, first-out method. Over time, as commodities have risen in price with inflation, the remaining inventory is carried on the books at a fraction of its replacement cost.

In periods of high inflation, 25 years ago here, and last week in Argentina, dealers resort to a pricing technique called NIFO next-in, first-out in order to survive. Consider a commodity like sugar or coffee. Prices can jump all over the place. Retailers who sell a can of coffee they paid $2 for at $3 will not last long if they must pay $4 to restock the shelf.

The FISH method is more a description of the results of a bad buying trip than an inventory valuation method. FISH, as you may have learned the hard way, stands for First In Still Here.

May all your inventories turn rapidly in the new year.

Peace.