Have you ever wondered how to make sure the oldest inventory, tasks, or data gets handled first? Whether you’re managing stock in a warehouse, organizing your to-do list, or just trying to avoid expired groceries, the “First In, First Out” (FIFO) method is key.
Understanding FIFO isn’t just for managers or accountants—it helps anyone streamline processes, minimize waste, and stay organized. In this article, we’ll break down what FIFO means, how it works, and offer simple steps to put it into practice in everyday life.
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What Is First-In, First-Out (FIFO) and How Does It Work?
First-In, First-Out, commonly known as FIFO, is a widely used inventory management and accounting method. Simply put, FIFO dictates that the oldest items in your inventory are the first ones to be used, sold, or shipped out. This straightforward concept helps businesses—especially those dealing with perishable goods or products subject to style changes—maintain accurate records and minimize waste.
If you’re curious about how FIFO applies in inventory, accounting, and even shipping, this guide breaks it all down in easy-to-understand steps.
Understanding FIFO: The Core Principle
At its heart, FIFO means “what comes in first, goes out first.” Imagine stacking boxes in a line—when you need a box, you always pick the one at the front that’s been there the longest.
How FIFO Works in Practice
- In inventory management: The oldest stock is sold or used before newer arrivals. This is especially important for products with expiration dates.
- In accounting: Costs are assigned based on the order goods are acquired; the earliest costs are the first to be recorded as cost of goods sold (COGS).
- In shipping and logistics: Items stored first are shipped out first, reducing chances of spoilage or obsolescence.
Let’s break down how FIFO is applied step-by-step.
Step-by-Step Guide: Applying FIFO
Using FIFO in your business doesn’t have to be complicated. Here’s how you can implement it:
1. Organization is Key
Start by organizing your stock. Shelve or stack items so that the oldest are most accessible.
Tips:
- Use clear labeling with dates received.
- Arrange perishables or fast-moving items up front.
- Regularly check inventory to ensure items don’t get stuck at the back.
2. Track Every Movement
Each time something comes in, note its acquisition date and cost. When a sale happens, remove the oldest items first—both from your storage and your records.
3. Update Your Inventory System
Whether you use paper logs or inventory software, be sure to:
– List items in order of acquisition.
– Deduct items in the same order from your inventory when sales happen.
4. Accurate Accounting Entries
When completing your financial records:
– Record the cost of goods sold (COGS) using the price of the earliest items acquired.
– Update remaining inventory values using the more recently acquired (higher-cost) inventory.
FIFO in Action: An Example
Consider a bakery that buys flour on three different dates, at three different prices:
- January 1: 100 lbs at $1/lb
- February 1: 100 lbs at $1.10/lb
- March 1: 100 lbs at $1.20/lb
If the bakery sells 150 lbs of flour in March:
– The first 100 lbs sold are at $1/lb, and the next 50 lbs are at $1.10/lb.
– The remaining inventory consists of 50 lbs at $1.10/lb and 100 lbs at $1.20/lb.
This method ensures older, possibly less desirable inventory moves first, and your profit calculations reflect the real flow of goods.
Benefits of FIFO
Using FIFO offers several advantages for businesses, large and small.
1. Simplicity and Transparency
- FIFO is straightforward, making it easier for teams to understand and implement.
- Ensures inventory records match the actual order goods are moved.
2. Fresher Stock and Less Waste
- Especially important for perishable goods.
- Reduces the risk of spoilage, obsolescence, or outdated products.
3. Clearer Financial Reporting
- In times of rising prices (inflation), FIFO generally results in lower COGS and higher reported profits.
- Inventory figures on the balance sheet are based on more recent costs, mirroring current market value.
4. Regulatory Compliance
- Accepted under most accounting standards, including IFRS and US GAAP.
- Simple audit trails for tracking inventory movements.
Challenges and Considerations with FIFO
While FIFO is popular, it’s not perfectly suited for all businesses or economic climates.
1. Inflation Impact
- In periods of rising costs, FIFO can inflate a company’s profits, leading to higher tax obligations.
- May not always represent actual replacement costs in profit calculations.
2. Not Ideal for Unique or High-Value Items
- For unique, high-value, or custom products, other methods like LIFO (Last-In, First-Out) or specific identification may work better.
3. Additional Storage Management
- Requires efficient warehouse practices to avoid “old” stock being hidden at the back.
- Need to train staff to always rotate stock correctly.
FIFO in Shipping and Costs
When you’re dealing with products that need to be shipped—whether domestically or internationally—FIFO helps you avoid unnecessary surcharges and losses due to expired or unsellable goods.
Cost-Saving Tips:
- Regularly audit stock to prevent over-ordering, which can lead to storage cost increases.
- For shipping, prioritize FIFO to minimize spoilage or loss, thus reducing write-off expenses.
- Use inventory management software that flags outdated or soon-to-expire items.
- Optimize warehouse layouts to make first-in stock easiest to reach, cutting down on time and labor costs.
Best Practices for Implementing FIFO
If you’re ready to make FIFO work for you, keep these best practices in mind:
- Label Everything Clearly: Use the receiving date and batch numbers to organize stock.
- Train Your Team: Ensure everyone understands the importance of moving the oldest inventory first.
- Automate Where Possible: Inventory management systems can automate FIFO tracking and alerts.
- Conduct Regular Inventory Counts: Spot-check shelves to ensure the physical stock flow matches records.
- Adapt FIFO to Fit Your Business: Some non-perishable goods may not need strict FIFO, but consistency is key.
When Should You Use FIFO?
FIFO is a great fit for:
- Food and beverage businesses: To avoid spoilage.
- Fashion retailers: To prevent outdated stock.
- Manufacturers: For components that can degrade or become obsolete.
- E-commerce and fulfillment: For products stored in warehouses before shipping.
However, if your products hold or increase in value over time, or if price volatility is high, you might want to consider alternatives.
FIFO vs. Other Methods
FIFO vs. LIFO
- FIFO sells oldest items first. During inflation, yields lower COGS and higher taxable income.
- LIFO sells newest items first, which can lead to higher COGS and lower profits (and lower taxes) but may not reflect actual inventory value as closely.
FIFO vs. Weighted Average
- Weighted average spreads costs evenly across all units. Less precise but can be simpler if you have many identical items acquired at different prices.
Each method has its place. Choose based on your business needs, tax strategy, and regulatory requirements.
Frequently Asked Questions (FAQs)
What is FIFO in simple terms?
FIFO stands for “First-In, First-Out.” It means the first items you add to inventory are the first ones you use, sell, or ship out. It’s a way to ensure stock stays fresh and records are accurate.
Why is FIFO important for businesses?
FIFO helps businesses manage inventory so they use or sell older goods first, reducing spoilage, obsolescence, and loss. It also improves financial accuracy and regulatory compliance.
How does FIFO impact profit calculations?
During periods of rising prices, FIFO reports lower costs for goods sold and higher profit margins. However, this can also mean higher taxable income.
What types of businesses benefit most from FIFO?
Businesses dealing with perishable goods—like food, pharmaceuticals, or fashion—benefit most from FIFO. It keeps inventory rotating, minimizes waste, and aligns with industry standards.
Can FIFO be used for shipping goods internationally?
Yes. FIFO is especially useful in global logistics, ensuring goods shipped out are always the oldest in storage. This reduces the likelihood of expired or obsolete products being sent, saving money and improving customer satisfaction.
In Summary
First-In, First-Out (FIFO) is a practical, transparent, and time-tested method for managing inventory and accounting in businesses of all sizes. By moving the oldest stock first, you ensure better product quality, minimize losses, and keep your financial reporting clear and compliant. With a few organizational steps and the right tools, FIFO can transform how you manage your stock—boosting efficiency and safeguarding your bottom line.
If you’re ready to bring clarity and freshness to your business operations, FIFO is a great place to start.
