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 yoghurt keeps moving to the back and gets covered up by other cups, you may miss the best-before date, leaving your yogurt for the bin 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 utilised, 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. While there are no specific reg­u­la­tions that mandate the use of FIFO in the United Kingdom, it is the preferred method under the UK GAAP (Generally Accepted Ac­count­ing Practice), a set of ac­count­ing standards published by the Financial Reporting Council (FRC). 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:

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:

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 kg. equals ap­prox­im­ately £1.74/kg.

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 shops 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.