Have you seen how the milk cooler in grocery stores is being restocked? The new stock goes in the back while the old stock comes to the front. This is what we call first in, first out, in the most realistic way. From an inventory perspective, businesses that follow the FIFO method operate in this way: the oldest inventory is sold first (first in), followed by the newest inventory. This approach helps businesses save items from expiration, spoilage, or becoming out of trend or out of season. Retail, wholesale, or manufacturing businesses that deal in perishable and fast-moving goods are the ones that mostly follow this method. 

Let’s break down this approach in detail: what it is, how you can calculate your inventory value using the first in first out inventory method, and why businesses prefer this model over others.

Let’s begin!

What is the first-in, first-out inventory method – FIFO Method

Method in which the oldest inventory (First in) is sold first (First out). The FIFO inventory management method is preferred by 55% of S&P 500 companies, and for good reason: it’s easy to calculate and complies with regulatory standards. This method is also widely used and required by the International Financial Reporting Standards (IFRS). 

How FIFO Works:

Business can calculate their inventory value using this simple FIFO formula

Ending Inventory = Remaining Units × Most Recent Purchase Price

COGS = (Units Sold × Oldest Prices) + (Remaining Units × Newer Prices)

For example:

To understand this, let’s take this example. 

You purchased inventory in three batches:

• January: 50 units at $10 each ($500)
• February: 50 units at $15 each ($750)
• March: 50 units at $20 each ($1000)

If you sell 80 units in April, your COGS calculation using FIFO would be:

• 50 units from January at $10 each = $500
• 30 units from February at $15 each = $450
• Total COGS = $950

Your remaining inventory would be valued at:

• 20 units from February at $15 each = $300
• 50 units from March at $20 each = $1000
• Total remaining inventory value = $1300

FIFO (First-In-First-Out) Method

Remaining Inventory After April Sale

This way, FIFO gives you a clear picture of your inventory costs, and you can then make decisions about restocking or whether you need to stock other goods based on that. 

Apart from inventory, FIFO is also used as an accounting method:

• As an inventory method: It ensures older products move out before newer ones
• As an accounting method: It assigns costs to inventory in the order of purchase

How you can calculate FIFO manually & with tools

For Manual Calculation:

• List all purchases chronologically (date, units, cost).
• Deduct sold units starting from the oldest batch.
• Multiply remaining units by their purchase prices for ending inventory 

Using a FIFO Calculator:

• Input purchase dates, quantities, and costs.
• Enter total units sold, tool auto-generates COGS and ending inventory.

Can your business use the FIFO method?

To determine if the first-in, first-out (FIFO) inventory method is right for your business, consider whether you control your inventory, if it is perishable, or has a short shelf life. In such cases, FIFO might be a good option. However, if you are in an industry where prices fluctuate dramatically or you need to track every item individually, FIFO may not work best. In that case, other methods like LIFO or weighted average costing might be a better fit for you. 

Industries where FIFO works best:

• Food and beverage (perishable goods)
• Fashion and apparel (seasonal items)
• Technology (quickly obsolete products)
• Pharmaceuticals (expiration dates)
• Manufacturing (materials with limited shelf life)

Inventory systems where FIFO works best:

• Perpetual inventory systems with real-time tracking
• Regular cycle counting operations
• JIT (Just-In-Time) inventory models
• Warehouse operations focused on freshness

Why do businesses prefer the FIFO method?

1- To find accurate inventory value:

With FIFO, you can find the accurate inventory cost because you calculate it according to the purchase amount given at that time. Since inventory costs vary due to various factors, such as inflation, a sudden shortage, tariffs or taxes, FIFO does not apply new rates to the old inventory. Instead, it calculates according to its original purchase value, allowing you to determine the accurate cost spent on the inventory. 

2- FIFO complies with accounting standards:

Under International Financial Reporting Standards (IFRS), companies are required to use FIFO when reporting their financial statements. Since FIFO is widely accepted in many countries, it is a suitable option for international businesses because it helps ensure compliance with various financial regulations. When businesses use FIFO, they follow a system where the first items purchased are the first ones sold, helping them accurately reflect their inventory and costs over time.

3- Better cash management and forecasting:

When you can easily align inventory cost with the sales you can predict how much cash has been spent already and how much more cash you will need to restock a certain amount of goods. This way, you can make informed decisions and not operate on guesses. 

FIFO vs. LIFO

Understanding how FIFO differs from LIFO (Last In, First Out) inventory method will give you more in-depth knowledge on whether FIFO is suitable for your business or LIFO. 

Where FIFO gives you accurate inventory costs and big profit margins, LIFO can offer tax advantages during inflation by reducing taxable income. It’s entirely up to the business to decide whether to go for FIFO or LIFO based on its nature. 

Source

Benefits your business will get with the FIFO Method

Financial benefits

• More accurate inventory values on balance sheets. 
• Higher profits are reported during inflation. 
• Better alignment of inventory flow with accounting. 
• Increases business value for potential investors or buyers. 

Operational benefits 

• Lowers the risk of product spoilage or becoming outdated. 
• Makes warehouse management and picking easier. 
• Reduces waste and costs related to it. 
• Helps utilize warehouse space better. 

Practical benefits

• Easily integrated into most inventory management systems. 
• Easy for staff to understand and follow. 
• Aligns more closely with actual inventory movement. 
• Provides consistent and reliable inventory records.

How you can start using FIFO today

1- Change your warehouse setup 

• Use gravity flow racks or pallet systems to allow FIFO (First In, First Out) movement.
• Design the warehouse layout so that it has clear paths for “in” and “out” flows.
• Label all inventory with receipt dates, lot numbers, or expiration dates.
• Create separate areas for new arrivals and items that are ready to pick.

2- Plan everything

• Train staff well on FIFO rules and procedures.
• Set up clear steps for receiving, storing, and picking items.
• Check the inventory flow often to make sure FIFO rules are followed.
• Record new inventory as soon as it arrives.

3- Use the right tools 

• Use inventory management software that works with FIFO.
• Implement barcode or RFID systems to track inventory movement.
• Set up alerts for older inventory.
• Create regular reports to confirm FIFO compliance.

The problems businesses face while implementing FIFO

FIFO sounds like the easiest and most applicable method so far. However, like any process or method, FIFO also has its drawbacks that pose challenges for many businesses. 

• Limited space in the warehouse makes it hard to rotate products. 
• Some products look different but have the same contents. 
• Different sizes of products make storage difficult. 
• Staff sometimes forget or skip FIFO rules. 
• It is hard to track items in stores where customers pick products. 
• Balancing FIFO with other picking methods, like batch picking, is a challenge. 

Solutions

• Offer regular training to staff. 
• Use clear visual aids like color coding and signs. 
• Check picking practices often. 
• Use automated systems to help follow FIFO when possible.

Conclusion

A proper method or process is very important for maintaining and operating a smooth business. In FIFO, the cost of goods that are sold represents the cost of the oldest inventory or the earliest purchased inventory. Businesses that operate under this model are more likely to make better financial decisions because of higher profit margins. 

If you are in the wholesale industry and wondering whether you should choose FIFO, then yes, go for it. For better inventory management, consider using an inventory management tool that saves you tons of time, manual labour, and cost that you can use in other areas like marketing and product development. 

FAQs

What is the first-in, first-out inventory method, or FIFO Method?

Method in which the oldest inventory (First in) is sold first (First out). The FIFO inventory management method is preferred by 55% of S&P 500 companies, and for good reason: it’s easy to calculate and complies with regulatory standards.

Q: Is FIFO mandatory for perishables?
A: No, it’s not mandatory, but it’s industry best practice to minimize waste and calculate accurate inventory values, which ultimately help you make informed decisions and save money.

Q: How does FIFO affect cash flow?
A: FIFO, or First-In, First-Out, is a way to manage inventory. It works on the idea that the first items bought are the first ones sold. When prices go up, this accounting method can show higher profits because it uses the cost of older, cheaper items against the money made from selling the newer, more expensive ones. This may make investors feel optimistic about the company’s earnings and growth. However, it also means the company has to pay more taxes since profits are calculated based on the selling price of the inventory, resulting in higher taxable income. So, while FIFO can make a company seem more attractive to investors, management should think about how it affects cash flow because of increased tax costs.

Q: Can I switch from LIFO to FIFO mid-year?
A: Yes, you can make this change at any time during the year. However, it’s important to talk to a tax advisor before making the switch, as it can affect your financial statements and your tax obligations. They can help you understand the implications of the change and ensure that you stay compliant with tax laws.