What is FIFO? Understanding First In, First Out in Inventory Management

The Essentials of FIFO

First In, First Out, commonly referred to as FIFO, is an inventory management technique used to ensure that the oldest inventory items are sold or used first. This approach is vital not only for maintaining the freshness and quality of stock but also for effective accounting practices. In essence, FIFO helps businesses manage their inventory in a way that mirrors the natural flow of goods, from acquisition to sale. Effective inventory management is a cornerstone of running a successful ecommerce business. Strategic planning of inventory can significantly influence your cash flow and profitability. Therefore, using the First In, First Out (FIFO) principle can be crucial. By adopting FIFO, you can achieve a more precise calculation of the Cost of Goods Sold (COGS), potentially lowering your ecommerce fulfillment expenses.

FIFO in Action: Accounting and Warehousing

FIFO is employed in two main areas: accounting for the Cost of Goods Sold (COGS) and in warehouse inventory management. In accounting, FIFO implies that the earliest purchased goods are the first to be sold, offering a consistent method to assess inventory costs despite fluctuations in market prices. This straightforward accounting practice helps in maintaining transparent financial statements. In warehousing and fulfillment, FIFO ensures that products are sold in the order they are received, minimizing the risk of being out of date or spoilage. This method is particularly used in grocery stores, where perishable items are systematically rotated to prioritize the sale of older stock, thereby reducing waste and financial loss.

Calculating Cost of Goods Sold with FIFO

Understanding the FIFO method’s impact on the cost of goods sold becomes clearer with a practical example. Imagine Sunny Blossoms, a hypothetical online store specializing in flower seeds. In March, Sunny Blossoms purchases 100 packets of sunflower seeds at $2 each. By the end of the month, they sell 60 packets and, anticipating spring demand, buy an additional 140 packets in April at $2.50 each due to a seasonal price increase. By the end of June, they have sold 180 packets and have 60 packets left in inventory. Applying FIFO accounting, the COGS for the 60 unsold packets would be $2.50 each, totaling $150. To calculate the COGS for the sold inventory, the formula would be: (100 x $2) + (80 x $2.50) = $400 This means, under FIFO, Sunny Blossoms considers the first sunflower seed packets sold to be those purchased at the initial lower price. After depleting the initial stock, the store accounts for the COGS of the additional seeds at the higher purchase price. This method provides a more precise reflection of inventory costs than averaging prices. FIFO helps Sunny Blossoms accurately track its actual goods sold cost as prices change, aiding in setting appropriate retail prices and preserving profit margins. Moreover, FIFO in warehouse management decreases the risk of surplus outdated stock, especially if seed varieties are updated or changed by suppliers.

Navigating Market Dynamics: The Bullwhip Effect

The “bullwhip effect” and the FIFO (First In, First Out) method are important concepts in managing a supply chain. In a perfect situation, everything in the supply chain would move smoothly and predictably, from the factory all the way to the customer. However, we often see that demand can change quickly and unexpectedly, leading to the “bullwhip effect.” This is when the supply chain starts to act unpredictably, similar to the unpredictable crack of a whip, which can cause issues in getting products where they need to go. FIFO is all about selling the oldest products first. But when the bullwhip effect happens, sticking to this method gets tricky, especially if customers no longer want those older products due to changes in their preferences. The main goal for anyone managing supply chain, from retailers to manufacturers, is to smooth out these unexpected changes as much as possible. While it’s hard to completely avoid the bullwhip effect, getting better at predicting what customers will want can help make things a lot less bumpy.

LIFO: An Alternative Perspective 

LIFO, or Last In, First Out, is another strategy for managing inventory where the most recently received items are sold or used first. This method can be particularly beneficial in certain scenarios. For instance, consider a fashion retailer that always wants to offer the latest trends to its customers. In this case, selling the most recent clothing lines first ensures that the offerings remain current, even if it means older collections may need to be sold at a discount to make room for new arrivals. Adopting LIFO means regularly reviewing older stock to prevent it from becoming outdated. This might involve discounting last season’s fashion to clear space for the latest trends. From an accounting perspective, LIFO can often show a higher cost of inventory because it assumes the more expensive, recent purchases are sold first. This could lead to lower taxable income, but also might not look as good on financial statements, showing higher costs and potentially lower profits on paper. Businesses might choose to use both LIFO and FIFO methods for different aspects of their operations. The key aim, regardless of the method chosen, is to effectively manage inventory levels to avoid excess stock, which can lead to costly storage fees. Regardless of whether you pick and pack orders from the newest items first (LIFO) or the older items (FIFO), it’s crucial to maintain balanced inventory levels to reduce overall storage costs.

Choosing Between FIFO and LIFO

Deciding between FIFO (First In, First Out) and LIFO (Last In, First Out) for inventory management boils down to what’s most efficient for your business and can help optimize costs and product flow.

Benefits of FIFO:

Adapts to Price Variations: It keeps track of how costs change over time, which is especially useful if your purchase prices tend to increase.

Minimizes Obsolescence: It ensures that older items are sold first, reducing the risk of having to discount or write off out-of-fashion or perishable items.

Simplifies Tracking: FIFO offers a clear and easy way to manage inventory, making it particularly user-friendly for smaller businesses.

Benefits of LIFO:

Tax Advantages: By accounting for the most recent (and often more expensive) purchases first, LIFO can lower the taxable income due to higher reported costs.

Latest Products First: It guarantees that customers receive the most current versions of your products, keeping your offerings fresh.

Lower Reported Income: Using LIFO can lead to a lower reported net income, which might be beneficial for certain tax situations.

However, it’s worth noting that LIFO can also have downsides, such as the potential accumulation of older, harder-to-sell stock. For products with a limited shelf life or those susceptible to becoming outdated quickly, FIFO is generally the more suitable approach, even if it might mean a higher tax liability due to lower cost deductions.

The Impact of FIFO on Storage Costs

Proper inventory management using FIFO, can significantly reduce long-term storage costs. By ensuring a regular turnover of stock, businesses can avoid the penalties associated with holding inventory for extended periods. This turnover is crucial for optimizing storage space and financial resources. Not effectively managing inventory to meet demand can lead to unnecessary expenses. Essentially, money should be used in areas that generate the most value. Holding onto excess inventory ties up capital that could be better used elsewhere, potentially affecting a company’s financial health. Long-term storage costs can significantly impact your profit margins. Third-party logistics providers (3PLs) often implement higher fees for items that remain in storage beyond certain periods, such as 180 or 365 days. This policy encourages businesses to maintain optimal inventory levels and avoid overstocking. Taking our Sunny Blossoms example, if they have 100 packets of sunflower seeds in stock and sell 300 packets within six months, they won’t face long-term storage fees because their inventory has efficiently rotated three times. This efficiency holds true even under a LIFO system where some packets might remain in stock longer. Conversely, if Sunny Blossoms only sells 60 packets in 180 days, they might incur extra fees for the 40 unsold packets. This situation also signals that Sunny Blossoms might need to reassess their stock levels, possibly reducing the number of packets they keep on hand to avoid unnecessary costs.

How 3PL Center Utilizes FIFO for Optimal Results

At 3PL Center, we understand the critical role that FIFO plays in inventory management, especially for items requiring stringent freshness, such as pharmaceuticals, pet medicine, and food products. Our expertise in implementing FIFO strategies ensures that your products maintain their quality while minimizing storage costs, thereby supporting your business’ growth and operational efficiency. Trust 3PL Center to manage your inventory with the precision and care that your valuable products deserve.

Pharmaceuticals:

Batch Processing: To ensure the utmost freshness and accuracy in our pharmaceutical handling, we implement batch processing techniques. This method allows us to group similar products together, making it easier to manage expiration dates and maintain the integrity of sensitive medications. Regulatory Compliance: Adhering to strict regulatory standards is paramount in pharmaceutical logistics. FIFO aids in compliance by ensuring that the first products received are the first shipped out, minimizing the risk of distributing expired or compromised products. Safety and Efficacy: The effectiveness of pharmaceuticals can diminish over time. FIFO ensures that customers receive medications at their peak efficacy, which is critical for treatment outcomes.

Electric Bikes:

Battery Longevity: Electric bikes are equipped with lithium batteries, known for their high performance but also for their potential to degrade over time. By implementing FIFO, we prioritize the movement of older stock, ensuring that the batteries maintain optimal charge capacity and longevity. Product Updates: The electric bike industry is fast-evolving, with frequent updates and improvements to models. FIFO ensures that customers receive the latest versions of products, enhancing satisfaction and reducing the likelihood of obsolescence. Safety Standards: The integrity of lithium batteries is crucial for safety. FIFO management minimizes the risk of battery degradation, which can pose safety hazards if not properly monitored.

Pet Food and Medicines:

Freshness and Efficacy: Just like human pharmaceuticals, the effectiveness of pet medicines can decline over time. FIFO ensures that the oldest stock, still within its prime efficacy period, is dispatched first, guaranteeing the health and wellness of pets. Nutritional Integrity: Pet food, especially those with natural or organic ingredients, can lose nutritional value and appeal over time. By applying FIFO, we ensure pets receive the freshest, most nutritious food options, supporting their health and vitality. Safety and Compliance: Pet products are subject to stringent safety and regulatory standards. FIFO aids in maintaining compliance by systematically managing inventory to avoid the distribution of expired or substandard products.

Food Products:

Peak Freshness: For perishable food items, freshness directly correlates with taste, texture, and nutritional value. FIFO is crucial in the food industry to ensure that consumers receive products at their peak quality, enhancing their dining experience. Waste Reduction: By prioritizing the movement of older inventory, FIFO helps in significantly reducing waste due to spoilage. This is not only economically beneficial but also environmentally responsible. Compliance with Food Safety Standards: FIFO complements food safety protocols by ensuring that products are sold within their safe consumption periods, thereby reducing health risks associated with spoiled or outdated food items. By integrating FIFO into our inventory management practices, 3PL Center ensures that all products, from pharmaceuticals to electric bikes to pet products and food items, are handled with the care and precision they require. This approach not only safeguards product quality and customer satisfaction but also aligns with industry best practices and regulatory standards.

WMS for FIFO Inventory Management

At the heart of our efficient FIFO-based inventory management lies our advanced Warehouse Management System (WMS), which is pivotal in seamlessly orchestrating the complexities of stock monitoring, reporting, tracking, and pallet visibility. This cutting-edge system offers an intuitive and comprehensive platform, enabling us to maintain meticulous oversight over inventory levels, ensuring that products are stored, managed, and dispatched with precision. The WMS’s robust capabilities facilitate real-time tracking and visibility, allowing for proactive management of stock movement and storage. This not only enhances the accuracy and efficiency of our operations but also provides our clients with unparalleled transparency and control over their inventory. Through this sophisticated technology, 3PL Center stands equipped to deliver exceptional service across all sectors, from pharmaceuticals and pet care to electric bikes and food products, ensuring optimal freshness, compliance, and customer satisfaction.

3PL Center for your Inventory Management and Fulfillment Needs

At 3PL Center, we use the First In, First Out (FIFO) method to manage inventory for a range of industries, from pharmaceuticals to electric bikes, pet care, and food items. This method, along with our top-notch Warehouse Management System, helps us handle products with great care and accuracy. By using FIFO, we make sure everything stays fresh and meets all the necessary standards, which helps us keep storage costs down and makes our customers happy. We’re all about giving our clients a clear, effective way to manage their inventory that’s specifically designed for their needs. Trust in 3PL Center to navigate the complexities of inventory management, ensuring your products are always in the right place at the right time.

FAQs on FIFO

What is FIFO?

FIFO stands for First In, First Out, a principle where the oldest inventory items are sold first, crucial for both retail and accounting purposes.

What is the rule of FIFO?

The rule of FIFO dictates that inventory should be sold or used in the same order it was acquired, particularly important for perishable goods to prevent spoilage.

Why is FIFO important?

FIFO is essential for preventing inventory from becoming outdated or expiring, ensuring that businesses sell their products in a timely and profitable manner.

How do FIFO and LIFO differ?

FIFO prioritizes selling older inventory first, while LIFO focuses on selling newer items first, impacting both inventory valuation and product freshness.