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Lowest In First Out (LOFO)
What does LOFO mean? – Basics of the valuation method
The LOFO method stands for ‘Lowest In First Out’ and describes a special method of inventory management and valuation. With this approach, goods are categorised according to their purchase price and managed systematically. The cheapest items leave the warehouse first, while more expensive products remain in storage for longer.
This simplified valuation method groups similar assets together. This enables companies to manage complex inventories more clearly. The Lowest In First Out system differs fundamentally from time-based storage methods, as the order is determined solely by price categories.
It is important to distinguish this method from other methods: While FIFO works according to storage time and LIFO according to reverse chronological order, LOFO is based exclusively on cost factors. This special feature makes the method interesting for specific areas of application, but also entails legal restrictions.
How does the LOFO method work in practice?
The practical implementation of Lowest In First Out requires a systematic approach. First, warehouse staff record all incoming goods with their respective purchase prices. This information forms the basis for subsequent sorting and removal from storage. Items with identical characteristics are grouped together, regardless of when they were put into storage.
When goods are removed from storage, the LOFO principle applies: employees first remove the items with the lowest procurement costs. This approach means that only higher-value stock remains in the warehouse. The system requires continuous monitoring and documentation of all price movements.
Technical aids such as warehouse management systems provide considerable support for these processes. They automate price recording and create corresponding removal sequences. Nevertheless, the administrative effort remains considerable, as every price change can result in a reorganisation of the warehouse structures.
When is the lowest in first out method used?
LOFO is particularly suitable for companies with highly fluctuating purchase prices for similar products.
Raw material traders or industrial companies with volatile material costs benefit from this method. The method makes particular sense when regular deliveries of the same goods are received at different conditions.
Goods of consistent quality are a prerequisite for the successful application of LOFO. Perishable or time-critical products are not suitable, as their shelf life is more important than their price. Metal goods, chemical raw materials or standardised components, on the other hand, meet these requirements perfectly.
Safety stock managers occasionally use the lowest in first out system to optimise costs. The focus here is not on rapid turnover, but on long-term inventory planning. This enables companies to make their internal calculations more accurate and better cushion cost fluctuations. However, it should be noted that legal restrictions limit external application.
Legal framework and admissibility
The LOFO method is subject to significant legal restrictions. Under commercial law, its use is generally prohibited for official balance sheets. This restriction results from a violation of the lower of cost or market principle, which requires a cautious valuation of assets. Identical prohibitions apply under tax law.
Companies may only use lowest in first out in internal cost accounting. Here, the method supports calculations and planning calculations without violating external accounting regulations. Controllers use LOFO data for decision-making and profitability analyses.
The legal background is understandable: LOFO leads to an overvaluation of inventories, as only expensive items remain in stock. This presentation does not comply with generally accepted accounting principles and could mislead investors. Therefore, always check that the system is used exclusively for internal purposes before implementing it.
Advantages and disadvantages of the LOFO system
Advantages of the LOFO method
Grouping similar goods simplifies complex inventory structures considerably. Employees do not have to record and manage each individual item separately. This increase in efficiency significantly reduces the time required for inventories and inventory checks. This advantage is particularly evident with small parts or standardised components.
LOFO leads to higher inventory values in accounting terms, as more expensive items remain in the system for longer. This can be advantageous for internal evaluations if companies want to present their financial position in a more optimistic light. This higher valuation is reflected in cost accounting and planning models.
Systematic cost recording ensures planning reliability. Controlling departments receive more accurate data for their analyses. The lowest in first out method enables more accurate forecasts of future material costs and their development. Use this information for strategic procurement decisions.
Disadvantages and challenges
The administrative effort is the biggest disadvantage. Warehouse staff must continuously record, sort and document prices. Each delivery requires the warehouse structure to be reorganised according to cost categories. These processes tie up considerable human resources and significantly increase operating costs.
Legal restrictions drastically limit practical application. Since LOFO is only permitted for internal purposes, companies must use other valuation methods for their official financial statements. This duplication of effort is rarely justified by the insights gained.
Practical challenges arise from the constant reallocations. Employees have to physically sort goods by price category and move them around. With large warehouse volumes or frequent price changes, this system quickly becomes uneconomical. Consider these factors when deciding for or against the lowest in first out method.
Alternative valuation methods at a glance
HIFO (Highest In First Out) is the direct opposite of LOFO. Here, the most expensive items leave the warehouse first, while cheaper goods remain in storage longer. This method is subject to the same legal restrictions as Lowest In First Out, but is used more frequently in practice as it appears to make more economic sense.
FIFO (First In First Out) is based on storage times rather than prices.
The goods that are stored first are also the first to leave the warehouse. This method is permissible under commercial law and is used in particular for perishable goods. LIFO (Last In First Out) works in reverse and gives priority to items that have been stored most recently.
FEFO (First Expired First Out) takes expiry dates into account and is ideal for food or medicines. Each method has specific areas of application and legal requirements. Choose the system that best suits your products, processes and legal requirements. A combination of different methods for different product groups is often the most practical solution.
Conclusion: LOFO in modern warehouse management
The LOFO method is a specialised internal cost accounting tool. Its application is limited to a few special cases where fluctuating purchase prices for similar goods play a role. Legal restrictions significantly limit its practical usefulness.
For most companies, established methods such as FIFO or average purchase prices offer better alternatives. These are legally unproblematic and less administratively burdensome. You should only consider Lowest In First Out if special internal calculation requirements justify it.
Modern warehouse management systems can easily implement LOFO from a technical standpoint. However, the decision for or against this method should be based primarily on business and legal considerations. Seek advice from experts before making any fundamental changes to your valuation methods.
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