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:

Items Date Amount Price per lb
Opening inventory 01.01.2022 200 lbs $2
Goods receipt 02.01.2022 100 lbs $1
Outgoing goods 05.01.2022 110 lbs 110 x $2
Goods receipt 07.01.2022 150 lbs $4
Outgoing goods 09.01.2022 200 lbs 90 x $2 + 100 x $1 + 10 x $4
Closing inventory 12.31.2022 140 lbs 140 x $4

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:

Items Date Amount Price per lb
Opening inventory 01.01.2022 200 lbs $2
Goods receipt 01.02.2022 100 lbs $1
Outgoing goods 01.05.2022 110 lbs
Goods receipt 01.07.2022 150 lbs $4
Outgoing goods 01.09.2022 200 lbs
Closing inventory 31.12.2022 140 lbs $4

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.

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