What is the FIFO method?

FIFO is a method of storing and managing goods. It states that goods should be taken out in the order that they arrive.

What is FIFO?

FIFO stands for “first in, first out” and is a method of reg­u­lat­ing the storage of different goods. Specif­i­cal­ly, the FIFO principle pertains to the order of product removal and the most effective method to calculate your inventory ac­cord­ing­ly. The FIFO method maintains a chrono­log­i­cal order. Products that have been in stock the longest, and were therefore added first, are also taken out first. This is an important tool to avoid wear and damage, es­pe­cial­ly when dealing with per­ish­able goods.

How does the FIFO method work?

Not every industry relies on FIFO, and in some sectors other methods make more sense. However, the first-in, first-out principle is par­tic­u­lar­ly important for the dis­tri­b­u­tion of food, medicines, medical utensils and certain bulk goods. You’re probably already familiar with the method from your re­frig­er­a­tor at home: If the yogurt keeps moving to the back and gets covered up by other cups, you may miss the best-before date, leaving your yogurt for the trash instead of a bowl. A first-in, first-out approach ensures that the oldest products get used first. In an economic context, FIFO works in a similar way, but on a much larger scale.

What are the re­quire­ments for the FIFO method?

While the FIFO principle is logical, the im­ple­men­ta­tion is not always that simple. Important for FIFO is a well-thought-out warehouse and ac­count­ing system. Main­tain­ing a clear overview of the inventory at all times is necessary for ac­cu­rate­ly es­tab­lish­ing the order in which goods are received or produced and ensures con­sis­ten­cy and re­li­a­bil­i­ty in inventory man­age­ment. Employees must be made aware of the potential for errors and trained ac­cord­ing­ly. On a larger scale, ap­pro­pri­ate FIFO-capable storage systems are rec­om­mend­ed. High-bay ware­hous­es, flow rack ware­hous­es with one entry and one exit, or silos are ideal for FIFO and support the efforts of the entire workforce.

What are the ad­van­tages of FIFO?

Properly thought out and im­ple­ment­ed, FIFO has numerous ad­van­tages. First and foremost, wear and tear, per­isha­bil­i­ty and ob­so­les­cence of products are sig­nif­i­cant­ly reduced, which, in turn, reduces costs. Mon­i­tor­ing shelf-life dates also fa­cil­i­tates the FIFO method. Existing storage space is optimally utilized, supply chain man­age­ment is improved, the overview of total inventory is main­tained, and spatial sep­a­ra­tion between incoming and outgoing goods is also often possible. In addition, a first in, first-out approach is easy to learn and use.

What FIFO methods are there?

FIFO plays a major role for the balance sheets of a company. After all, inventory is con­sid­ered part of the company’s assets and must be reported ac­cord­ing­ly. FIFO is not regulated at a federal level in the U.S:, but it may be required by state or local reg­u­la­tions to ensure the safety and quality of products. While U.S: GAAP (Generally Accepted Ac­count­ing Standards) allows for other valuation methods, the FIFO method is in­ter­na­tion­al­ly rec­og­nized. The FIFO principle assumes that goods are delivered in the order in which they are received. In­di­vid­ual items are then valued according to the last purchase price.

The perpetual FIFO method

In perpetual FIFO, the inventory is re­cal­cu­lat­ed after every single purchase or sale. Although this FIFO method is very costly, it reflects the course of business very ac­cu­rate­ly. It allows you to keep track of your income, expenses, and current inventory levels.

In the following example, we’ll look at permanent FIFO. Let’s imagine a company that produces an as­sort­ment of candy and uses sugar for this purpose. The de­liv­er­ies and with­drawals are recorded in a table that looks like this:

According to the FIFO method, it can be assumed that stocks delivered first are also consumed first. The entire first goods issue therefore still comes from the initial stock at $2, resulting in a total value of $220. With the second with­draw­al, on the other hand, it gets a bit more difficult. According to FIFO, the rest of the initial stock at $2 was used. In addition, the entire first delivery was used at $1 and a part of the second delivery at $4. Taken together, this results in a value of $320.

The ending inventory, on the other hand, can only consist of the second delivery at $4 and thus has a value of $560. The material con­sump­tion is made up of the two items under “Outgoing goods” and is therefore $540.

The periodic FIFO method

The periodic FIFO method does not take into account each in­di­vid­ual change, but instead performs a cal­cu­la­tion at the end of a period, i.e., at the end of the year. This FIFO method takes the prices of the last goods receipt as its basis. Although this is somewhat simpler, it also leads to more in­ac­cu­rate results. The cor­re­spond­ing periodic FIFO table would look like this:

When applying FIFO, the closing inventory can only be done after the last delivery. Ac­cord­ing­ly, it is valued at $4 and is $560. Now you ad­di­tion­al­ly valuate the material costs and use the following formula for this:

Evaluated opening inventory + evaluated goods receipts - evaluated closing inventory

In our example, this means: (200 x $2) + (100 x $1) + (150 x $4) - $560 = $540. To value the in­di­vid­ual issues, divide this value by the total issues: $540 divided by 310 lbs equals ap­prox­i­mate­ly $1.74/lb.

What is the dif­fer­ence between FIFO and LIFO?

In addition to the FIFO method, there is also the LIFO method, i.e., last in, first out. Here, items that were added last are taken out first. This principle makes work easier, as goods do not have to be re­arranged. Also, the available space is used optimally, which is a great advantage, es­pe­cial­ly for small online stores and their e-commerce dis­tri­b­u­tion channels. LIFO can be ad­van­ta­geous when goods purchased at higher prices are offset against current sales. However, this method is only suitable to a limited extent, es­pe­cial­ly when dis­trib­ut­ing products with ex­pi­ra­tion dates.