Understanding FIFO: What It Is and How It Works
October 29, 2024
October 29, 2024
If you’ve ever worked in a warehouse, retail store, or any business dealing with inventory, you’ve likely encountered the term "FIFO" or “First-In, First-Out.” But what exactly does it mean, and why is it an essential concept for businesses to understand and implement?
At its core, FIFO is an inventory management method where the oldest stock is sold or used before newer items. It applies to everything from perishable goods, like food and pharmaceuticals, to non-perishable inventory, such as electronics or clothing. By following this method, businesses ensure that products are moved efficiently through the supply chain, reducing waste and improving profitability.
FIFO stands for First-In, First-Out. This means that the first items to enter inventory (either through production or purchase) are the first to be sold or used. It's one of the most widely adopted methods in both inventory management and accounting because it ensures older stock is not left sitting on shelves for too long.
To understand this better, let’s compare FIFO with another common method, LIFO (Last-In, First-Out). Under LIFO, the most recently produced or acquired items are sold first, leaving older stock in storage. LIFO can sometimes be used in industries where products don’t expire or where newer items may need to be prioritized, but for many businesses—especially those dealing with perishable goods—FIFO is the go-to method.
1. Reduced Spoilage and Obsolescence One of the most significant advantages of FIFO is that it helps minimize the risk of products expiring, spoiling, or becoming obsolete. This is particularly critical for businesses that deal with food, pharmaceuticals, or other perishable goods. By prioritizing older inventory, businesses can avoid unnecessary waste and ensure that products are sold or used before their expiration dates. For non-perishable goods, FIFO helps prevent items from becoming outdated or obsolete, especially in fast-paced industries like technology or fashion.
2. Improved Tracking and Inventory Visibility Implementing FIFO provides businesses with greater visibility into their inventory flow. By ensuring that the oldest stock is sold or used first, companies can maintain a clear paper trail, which is invaluable for tasks like batch recalls, warranty claims, and demand forecasting. For example, if a batch of products is found to be defective or needs to be recalled, a FIFO system allows businesses to track exactly when that batch entered the warehouse and which customers received it, reducing the scope and complexity of recalls.
3. More Accurate Financial Reporting From an accounting perspective, FIFO ensures that the cost of goods sold (COGS) reflects the actual cost of the older inventory that was sold. This gives a more accurate picture of profitability, particularly during periods of rising prices. Since the older, often cheaper, inventory is sold first, the reported profit margins may be slightly higher compared to other methods like LIFO. FIFO also aligns more closely with the actual flow of goods in many businesses, making financial reporting more straightforward and reliable.
4. Regulatory Compliance In some industries, such as food and pharmaceuticals, the use of FIFO is not just a best practice—it’s a legal requirement. Regulatory bodies such as the FDA (Food and Drug Administration) and similar organizations globally mandate FIFO to ensure that products reaching consumers are safe and within their expiration dates. This makes FIFO an essential part of staying compliant with industry standards and avoiding costly fines or recalls.
While FIFO has many benefits, successfully implementing it requires careful planning and execution. Here are some key factors to consider:
While FIFO is a popular method, it’s not always the best fit for every type of business. Industries that deal with non-perishable, non-seasonal items might not prioritize FIFO, as there's less risk of inventory expiring or becoming obsolete. Additionally, during times of inflation, using FIFO may result in lower reported profits since the cost of goods sold will reflect older, potentially cheaper inventory.
However, for companies in sectors where product shelf life is a concern, such as food, pharmaceuticals, cosmetics, or any fast-paced market where trends change quickly, FIFO remains the gold standard.
Understanding and implementing the FIFO method is important for businesses seeking to optimize their inventory management, reduce waste, and comply with industry regulations. It not only ensures that older inventory is utilized efficiently but also improves tracking, financial accuracy, and visibility throughout the supply chain.
At Fast Fulfillment, adopting FIFO is essential for helping our clients streamline their operations, minimize losses, and ensure smooth, compliant processes. Whether you're managing a warehouse, overseeing procurement, or simply looking to understand more about supply chain management, knowing the basics of FIFO will give you valuable insights into how businesses maintain efficiency and profitability.