The FIFO method works by ensuring that inventory is rotated, with older products being used or sold first.
It relies on effective organization, accurate tracking, and appropriate warehouse design to function smoothly.
If you use this method, you can reduce waste, maintain product quality, and meet regulatory standards.
Learn more about the FIFO method below.
How Does the FIFO Method Work?
First in, first out — that is what the FIFO method is about.
The FIFO method is a widely used inventory management technique that prioritizes the movement of goods based on their age.
Its fundamental principle is simple: the first items to enter a warehouse or inventory system are the first to be sold or used.
This system ensures that older stock is used before newer stock, which is important for industries dealing with perishable goods or products with limited shelf life.
In a typical FIFO system, inventory is organized in a way that the oldest items are easily accessible and moveable.
When new stock arrives, it is placed behind the existing stock so that the older items are used or sold first.
What Is the Difference Between the FIFO Method and the LIFO Method?
The FIFO (First-In, First-Out) and LIFO (Last-In, First-Out) methods are two of the most common inventory management strategies.
Inventory Flow
The primary difference between them lies in the order in which inventory is sold or used.
The FIFO method dictates that the first items to enter the inventory are the first ones to be sold or used. In other words, older stock is always moved out first.
The LIFO method operates on the opposite principle, where the most recently purchased or produced items are the first to be sold or used.
Newer stock is moved out before older stock, regardless of when it was first received. It does not prioritize the oldest stock.
Profits and Taxes
FIFO tends to reflect the current market price of goods more accurately because the most recent purchases are not immediately sold off.
In a time of rising prices, it results in lower Cost of Goods Sold (COGS), since older and usually cheaper inventory is sold first.
This leads to higher net income, but it also leads to higher taxes due to the increased reported profits.
Under LIFO, the most recent and typically higher-priced inventory is sold first, meaning that COGS will be higher, especially during periods of inflation.
This results in a lower net income because of higher expenses, which can reduce the taxable income.
However, it can distort the balance sheet, as the remaining inventory may be undervalued compared to its market value.
6 Benefits of Using the FIFO Method
Below are the benefits of the FIFO method, and why it is a widely adopted inventory management strategy.
1. It Reduces the Likelihood of Items Expiring or Becoming Obsolete
The FIFO method ensures that older items, which were received first, are the first to be sold or used.
This systematic cycling of stock minimizes the chance that goods will sit in storage for extended periods, which is crucial for products with a limited shelf life.
In the case of non-perishable items, it reduces the risk of technological or seasonal obsolescence.
2. It Lowers the Risk of Legal Issues Arising From Selling Outdated or Expired Products
If you adhere to the FIFO method, you protect yourself from inadvertently selling out-of-date stock, ensuring customer safety and regulatory compliance.
It also reduces the chances of recall costs by maintaining quality control and reducing the likelihood of quality-related incidents.
3. It Maintains Consistency in Product Quality by Cycling Older Stock Out First
If you prioritize older items, you can maintain a consistent quality standard and always deliver fresher products to customers.
This aligns with consumers’ expectations of reliable product quality and enhances brand reputation, building consumer trust.
4. It Helps Comply with Industry Regulations and Standards in Sectors Where Freshness Is Critical
Many industries are governed by strict regulatory standards that require regular monitoring and quality control of product lifecycles.
The FIFO method can help you comply with these regulations by ensuring that inventory moves in a predictable pattern, mitigating the risk of holding expired stock.
5. It Is Easier to Manage and Organize Inventory by Systematically Moving Older Stock First
The FIFO method enhances organization within inventory systems by creating an orderly flow of goods that is simple to monitor and manage.
You can predict stock movements, making restocking and inventory audits more straightforward.
It also minimizes the chances of losing track of items that have been in storage for a long time, reducing the risk of misplaced or expired stock.
6. It Minimizes the Chances of Returns and Complaints
Adopting FIFO directly correlates with reduced customer complaints and returns, as this method delivers higher-quality, fresher products.
When customers receive items close to their production date, they are less likely to experience issues with product quality, reducing the risk of dissatisfaction.
Conclusion
While FIFO offers many benefits, it does come with challenges.
In some cases, the FIFO method may lead to increased storage costs because the older stock needs to be kept in accessible areas, which can take up more space.
If you need help managing your space, check out our solutions here.
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