FIFO is the most simple and most effective method for managing business inventory. “The oldest stock in the warehouse is sold out first using the FIFO method, which reduces wastage.” It is particularly useful in retail, e-commerce, and businesses dealing with seasonal and perishable products. Integrating the FIFO method with emerging technologies like AI can enable error-free inventory management in a company. The FIFO method has been used for many decades, especially gaining prominence in the early 20th century, as businesses aimed for more accurate ways to manage and value inventory.
Have you ever wondered how grocery stores ensure the milk at the back of the shelf isn’t expired? That’s FIFO in action! FIFO full form is “First-In, First-Out,” it is a method that’s all about using or selling the oldest stock first, just like rotating milk cartons to keep it fresh. It’s a smart approach for businesses dealing with perishable goods like food or medicine because nobody wants to find stale bread or expired tablets on the shelf. FIFO ensures products are always in their best condition and don’t expire when they reach customers. That also prevents wastage and keeps inventory fresh.
What Is The FIFO Method?
FIFO(First in, first out ) is a simple and effective inventory management tool. FIFO( first in and first out method) means the oldest products of a Company should be sold first to reduce spoilage or obsolescence. This method involves systematic warehouse storage inside the 3PL warehouse by keeping the newer items behind the older ones. It is beneficial for businesses handling perishable goods or high turnover. Inventory management is an essential part of running a successful business. Properly organizing and tracking inventory can avoid overstocking and out-of-stock problems.
FIFO even plays a vital role in the financial management of the business. The method helps to calculate the cost of goods sold (COGS), which reflects the cost of the oldest inventory. High COGS indicate inefficiencies in inventory management, while low COGS indicate cost-effective warehousing operations.
FIFO is essential for Indian businesses because it improves efficiency, reduces logistics costs, and enhances customer satisfaction. It helps to keep track of the supply and stock and ensure that older inventories are shipped first to the customer. It allows a business to identify inventory discrepancies and make adjustments quickly.
How Does the FIFO Method Work?
We are listing a step-by-step guide on the basic principle of the FIFO method.
1. Track Your Inventory
Your first step should be to keep track of the inventory. You should note the date, number of items, and cost of each item flowing into the logistics warehouse.
2. Sell First The Oldest Items
The older items acquired in the modern warehouse should be sold before the new stock is sold. It reduces the chances of spoilage, especially for perishable goods.
3. Calculate COGS
You need to calculate COGS (Cost of goods sold) based on your older inventories in the warehouse.
COGS Formula
COGS = Quantity of goods sold * Cost of old inventory items
Remaining Inventory = Remaining stock quantity * cost of new inventory items.
FIFO Example – Imagine a store that is selling apples. The store purchases 100 Kilograms of apples on 1st June. Each Kilogram of apple costs 50 rupees.
Again, on 10th July, the store purchased 100 kilograms at Apple, and each Kilogram cost at that time 55 Rupees.
The store sold 120 Kilograms of apples on 11th July.
Now, by using FIFO
Batch 1 =100 * 50 = Rs5000
Batch 2 = 20 * 55 = Rs 1,100
So COGS = 5000 + 1100 = Rs 6100
The remaining inventory will be 80 * 55 = Rs4,400
FIFO is quite important here because when the older apples are sold first, it reduces the chances of spoilage and wastage. The customer can get fresh apples and become happy. The inventory reflects the current market prices of the apples.
FIFO Method: Pros and Cons
Pros
- In the FIFO method, old items are sold, ensuring minimum wastage, especially for perishable products like food and medicine.
- The FIFO method is a simple and easy-to-understand method.
- The FIFO method provides fresh products to the customers and makes them happy.
- It simplifies inventory tracking because products are sold in a way they are received inside the warehouse.
- It is a reliable way to calculate profit margins and ensure that a business owner will not have financial issues.
Cons
- This method can increase discrepancies when the COGS value increases dramatically. Businesses may have to pay higher taxes during inflation.
- It can negatively affect profits when the product cost rises very high.
FIFO Vs. Other Inventory Methods
FIFO Vs. LIFO
Are you a retailer, wholesaler, or manufacturer? If yes, you need to invest significantly in the inventory. Keeping track of inventory balance is quite essential for a successful business.
FIFO and LIFO are the two most common inventory models. Below, we list the differences between the LIFO and FIFO methods.
- The oldest items are sold first using the FIFO inventory method, but new items are sold first using the LIFO method.
- The remaining inventory in FIFO indicates the recent market costs, but the remaining inventory in LIFo indicates the old inventory costs.
- FIFO usually results in high profits, which leads to high taxes. However, the LIFO model does not provide much profit, and that reduces tax liabilities.
LIFO is based on the theory that the recently brought inventory items sold out first to the customers. This means that inventory located at the back will never be brought to the front, resulting in spoilage or being outdated.Â
They will lose their value with time. So, in short, FIFO provides a clear picture of the present financial market, which LIFO cannot offer. Hence, the LIFO method is not widely used in India.
FIFO Vs. Weighted Average Costs
Old inventory is used first in the FIFO method. However, the average cost of all the inventory is applied to the weighted average costs.
Weighted Average Cost Per Unit = (Total cost of goods available for sale / Total units available for sale)
Let’s explain with an example:
A businessman purchases bags various times in a months
- He purchased 100 bags at Rs200 each = Rs20,000
- He then purchases 200 bags at Rs 250 each = Rs 50,000
- He then purchased 150 bags at Rs 300 each = Rs 45,000
Total cost of goods available for sell = 2000 +50,000 +45,000 = 1,15,000
Total units available for sell = 100 +200 +150 = 450
Weighted Average Cost Per Unit = (Total cost of goods available for sale / Tota units available for sale) = 1,15,000 * 450 = Rs 255.56 /Kg
The shop sold 200 bags
COGS = 255.56 * 200 = Rs 51.112
Ending inventory = 250 * 255.56 = Rs63,890
Let’s discuss the same example with the FIFO method
Total bags sold = 200
The bsuinessman sold 100 bags from the 1st purchase at 200Rs each = Rs 20,000
The businessman sold 100 bags from 2nd purchase at Rs 250 each =Rs25,000
COGS = (100 * 200) +(100 * 250) =(20,000) +(25,000) = 45,000
Remaining Inventory =(100 * 250) + (150 * 300) = 25000 +45000 =Rs70,000
FIFO VS Specific Identification
The FIFO method always sells the oldest inventory first. However, a specific identification method reflects the actual item costs and is best for highly valuable items. This inventory valuation method tracks every product in the inventory from its entry to its exit.
Let’s discuss this with an example:
- The store purchased watch 1 at Rs50,000
- The store next purchased watch 2 at Rs 75,000
- The store then purchased watch 3 at Rs 80,000
- The store sold watch 2 for Rs 1,00,000
According to the specific identification method, COGS = Rs75,000
Profit = 1,00,000 – 75,000 = Rs 25,000
Remaining Inventory = 50,000 +80,000 = Rs1,30,000
When FIFO Might Not Be Ideal And Specific Tracking Becomes Necessary?
FIFO works well for items like groceries, clothes, or perishable products. Here, older items can be sold first to avoid spoilage or outdated products. However, this will not apply to highly valuable items like watches or jewellery. Each highly valuable item has its own cost. Selling it based on FIFO can misinterpret the actual cost of the sold item.
Impact Of FIFO On Financial Statements
- Inventory Valuation – The remaining inventory in the FIFO method reflects the current price.
- Profitability- The FIFO inventory management method has a significant impact on business profitability. The COGS is based on the old purchase price. It reduces the total expenses and increases the gross profit.
- Tax Implications – The tax liability is higher in the FIFO inventory method because of increased profits.
Best Practices For Implementing FIFO
- Organize Inventory Shelves – You should place older inventories at the front of the store and new inventories at the back of the shelves.
- Leveraging Technology – Advanced technologies like warehouse and inventory management systems, scanners, and barcodes can automate inventory tracking operations and reduce human error.
- Training Staff – You should educate employees about the FIFO principles, advanced software, and the benefits of selling old items.
- Regular Audits – You should periodically check whether the inventories are organized and kept according to the FIFO method.
Emerging Technologies That Enhance FIFO Efficiency
1. RFID And Barcode Scanner
Radio Frequency identification tags (RFID tags) are small devices that store and transmit data about a product. These devices are used in inventory management to increase accuracy and efficiency, particularly in the first in and first out method. Businesses use barcode scanners in inventory management to track goods and improve efficiency.
2. Automation tools
Pallet shuttle transport and organize the stock based on the entry date. Conveyor belts are even automation tools that help to move the product from one place to another efficiently. They reduce labor costs and ensure constant adherence to FIFO principles.
3. AI Powered Systems
AI algorithms analyze historical data and seasonal trends and demand forecast inventory needs. These systems avoid issues like overstocking and out-of-stock issues.
Why Is FIFO The Preferred Method For Inventory Management?
1. Simple And Reliable
FIFO follows a simple rule, i.e., old items are first sold or dispatched. This concept requires minimal training and easily understood.
2. Compliance With Regulatory Standards
FIFO complies with regulatory standards, making it easier for the regulatory bodies to verify.
3. Practicality In High Turnover Industries
FIFO is quite essential in various industries. We are listing them below.
A. FMCG(Fast moving consumer goods)
Like beauty and personal care products or beverages, FMCG has expiration dates. FIFO ensures that the older products stored first to reduce spoilage. Many online platforms like Amazon and Flipkart Seller offer inbuilt insights to identify these inventories.
B. Pharmaceuticals
Drugs and medical supplies have a particular expiry date. Selling them earlier helps reduce outdated products.
C. Retail
Seasonal or perishable products benefit from the FIFO method to prevent spoilage.
Conclusion
The FIFO method is an essential tool in business. It aims to optimize inventory management, reduce wastage, and maintain profitability. Its simple and reliable approach and compliance with regulatory standards suit numerous industries today. A business owner can achieve long-term operational success by adopting the method.
AAJ Supply Chain Management
