What Is the First-In, First-Out (FIFO) Method?

Definition of FIFO

The term "FIFO" stands for "First In, First Out," and it represents a crucial concept in inventory management. But what exactly does FIFO entail? FIFO is an inventory valuation method based on the principle that the goods or products acquired first should be the first ones to be sold and used. In simpler terms, FIFO ensures that the oldest inventory items are the ones sold and shipped to customers before more recently acquired inventory.

This method is of utmost importance in effectively managing inventory and plays a vital role in various industries, including retail, manufacturing, and supply chain management. To fully comprehend its significance and application, let's delve deeper into how FIFO works and why it's essential for businesses dealing with inventory products.

FIFO vs. LIFO

Another commonly used inventory valuation method is the last in, first out method, or LIFO. While LIFO and FIFO might sound similar, they have crucial differences.

The LIFO method differs from the FIFO method because it follows a different sales pattern. LIFO is a valuation method where the last products produced or purchased in your inventory are the first ones you sell, meaning your newest stock is sold first.

How Do You Calculate FIFO?

You can calculate FIFO by adding the cost of your earliest inventory items sold. For example, if you sell 5 units of inventory, the price of the first 5 items you purchased as inventory is added together.

A number you might need access to when calculating FIFO is your ending inventory. If you’re looking for how to calculate ending inventory, you can use the formula: Beginning inventory + net purchases - cost of goods sold = ending inventory.

What is FIFO Accounting? FIFO Method: Step-by-Step

Knowing how to do FIFO is crucial to maximizing the benefits of the FIFO inventory costing method. But what is FIFO in accounting, and what does FIFO require?

1. Understand what FIFO is. Before you can start using this inventory valuation method, you need to understand the ins and outs of the FIFO method. This valuation method assumes that your oldest inventory is the inventory that will sell first.
2. Record your initial inventory volume, noting the cost and quantity of what you already have in stock.
3. As you make new inventory purchases or produce new products, record your new inventory volumes, including the cost and quantity of each inventory batch.
4. Track your sales, selling the first items you purchased in your inventory before newer items are purchased. When a sale occurs, match the sale to the cost of your oldest available inventory.
5. Calculate your ending inventory at the end of an accounting period.
6. Determine the total cost of goods sold using the formula: Starting inventory + purchases - ending inventory = cost of goods sold.

What Are the Benefits of the FIFO Method?

Beyond knowing how to use FIFO method for your inventory valuation processes, it’s important to understand the benefits of using this method over other valuation options. Here are some of the benefits of using the FIFO perpetual inventory method.

Higher Valuation for Ending Inventory

A notable benefit of using the FIFO method is that this method provides a higher valuation for your ending inventory. Inflation raises the price of your inventory as it sits in your warehouse, which means that the goods you purchase first are typically cheaper than your newer inventory.

The FIFO method assumes that your older inventory is sold first, meaning your ending inventory will contain products with a higher valuation, ultimately making your ending inventory worth more. A higher valuation for your ending inventory is important because it helps enhance your balance sheets and minimizes write-offs, making the FIFO method a viable option for your financial well-being.

FIFO Provides Real-Time Inventory Data

Access to up-to-date inventory data is important for businesses to understand what their inventory costs at any given time. The FIFO valuation method is beneficial because it offers a real-time data assessment of your inventory and where your business stands. This real-time information is especially useful for companies dealing with large inventory volumes!

FIFO Reflects Inventory Movement

Another advantage of the FIFO method is that this method often reflects your inventory movement. Many organizations find the FIFO method beneficial because it accurately shows the order in which your inventory is sold – particularly important for businesses with a short shelf life, like grocery stores.

Using FIFO helps simplify the entire inventory accounting process, eliminating the need to worry about complicated accounting tasks and ensuring an accurate understanding of your inventory’s natural cycle.

FIFO Has Accurate Margins

Accurate profit margins are another advantage of the FIFO valuation method. The FIFO method reflects your true net and gross profits as inventory prices increase, eliminating any confusion you might encounter during financial reporting.

With the FIFO method, the values used for your cost of sales figures are accurately reflected on your profit and loss statement, a benefit not all valuation methods have.

Enhance Your Inventory Counting With Zupan

So, what is FIFO method? The FIFO process is an inventory valuation method where your oldest inventory is sold first and has several benefits, including higher ending inventory valuation and accurate profit margins.

Beyond your inventory valuation method, you need solutions to help your organization thrive. Inventory counting is a critical component of tracking your inventory and ensuring accuracy.

Zupan provides advanced inventory counting solutions to help you navigate inventory counting better than ever before. Learn more about our inventory counting software today!