What is FIFO in inventory management?

If you’ve had any experience with inventory, you’ve probably heard the phrase “Fifo” being thrown around now and again. Instead of nodding along with no clue whether FIFO is an Italian restaurant chain or a dog’s name, read our ultimate guide below. We’re covering what FIFO means, and whether it’s the right method for your business. 

What is the FIFO method?

FIFO, or first in, first out, is an inventory management method where your oldest inventory items get sold or used first. One great example of this is the discount stickers at the supermarket. Older food is pushed to be sold by heavily discounting the item. That’s why FIFO works best for perishable goods — if they don’t get sold, you don’t make a profit. 

It does also work for businesses that sell non-perishables, but want to keep their inventory fresh and up-to-date. 

How does FIFO work?

The FIFO method is, surprisingly, as straightforward as it sounds. Here’s a quick guide on how it works: 

1. Receiving inventory — When new inventory arrives, it’s placed right at the back of the storage area, while older inventory gets pushed to the front. 

2. Selling or using inventory — As sales come in or materials need to be used for production, the older inventory is used first. Items that have been sitting in storage the longest are the first to go. 

3. Keeping records — Having accurate records means it’s easy to track how old your inventory is so that the oldest items are always prioritized. 

Pros and cons of FIFO inventory management

Like any strategy, FIFO has both its strengths and weaknesses. Let’s break them down so you can decide whether it’s right for you. 

Pros of FIFO inventory management

• Reduces waste — FIFO ensures that all your older inventory is used or sold first so you can reduce the risk of spoilage. 
• Improves your cash flow — By selling all your older inventory first, you’re far less likely to have your money tied up in unsold stock. 
• Simplifies accounting practices — FIFO aligns well with your actual and physical cash flow of goods, making it far easier to track inventory costs and profits. 
• Complies with regulations — For businesses dealing with perishables, FIFO helps them to comply with health and safety rules. 

Cons of FIFO inventory management

• Complexity of storage — With FIFO, you need to organize your storage very carefully so that your older inventory is always accessible. 
• Potentially higher taxes — For times when prices rise, FIFO results in a lower cost of goods sold (COGS), which increases reported profits and taxes. 
• Overstated inventory value — Since the oldest and typically cheapest inventory is used first, your balance sheet will show a higher inventory valuation than it really is.

What’s the difference between FIFO and LIFO in inventory management?

FIFO’s arch-nemesis in inventory management is LIFO, or last in, first out. FIFO focuses on the oldest inventory first, while LIFO takes a completely opposite approach, using the newer inventory first. Here’s a quick comparison: 

FIFO

• Oldest inventory is used first
• Reduces waste and obsolescence
• More accurate reflection of physical inventory flow
• Lower COGS in times of rising prices

LIFO 

• Newest inventory is sold first
• Can result in lower tax liabilities in times of rising prices
• May lead to outdated inventory remaining unsold
• Not suitable for perishable goods
• Only legal under GAAP in the US

Choosing which method works for you depends on your business needs and your overall financial goals. 

How to choose the right method for you

Choosing the right inventory management method is like choosing the right tool for a construction job — it depends on the specifications of the project and what you want to achieve. The same applies to your inventory. Here are some factors you have to consider when choosing between FIFO, LIFO, or something else entirely. 

1. The nature of your goods 

If you deal in perishable goods or items with a short shelf life, FIFO is usually the better choice. For non-perishables, LIFO might be more suitable. 

2. Your financial goals 

Consider how each of these methods will have an affect on your financial statements. FIFO results in far higher COGS and lower profits during times when prices are rising. LIFO can actively reduce your tax liabilities, so which is best depends on your cash flow. 

3. Regulatory requirements 

You need to make sure you’re staying compliant with industry regulations, and FIFO is usually a requirement for food and pharmaceuticals. In this sense, the choice may have already been made for you. 

4. Your business’ size and complexity 

Larger businesses with more complex inventory systems may benefit from how simple FIFO is. Smaller businesses may prefer the flexibility that other methods provide. 

5. Storage and logistics 

FIFO needs complex storage to work, like being able to store your old inventory in an accessible place. This might not be feasible for businesses with a smaller warehouse or storage space. 

FIFO inventory management example

Let’s look at a simple breakdown of how FIFO might work in a real-life scenario. 

A smoothie bar receives shipments of fresh fruit every Monday and Thursday. They use FIFO to manage their inventory. Here’s how. 

1. Monday — A shipment of oranges arrives. These go right to the front of the storage area. 
2. Thursday — A second shipment of oranges arrives. They go directly behind Monday’s batch. 
3. Saturday — During the morning rush, employees use the Monday batch first to make sure they don’t perish. 

Of course, this is a simple example. But it does still highlight how FIFO, in this case, stopped the oranges from going bad, reduced waste, and kept the juice fresh and delicious. 

Other valuation methods

FIFO is undoubtedly a popular choice, but it’s not the only option out there for your business. Here are just a few other inventory valuation methods you might want to consider using: 

LIFO

As we’ve already mentioned, LIFO uses the newest inventory first and foremost. While this doesn’t seem to make sense, it’s great for tax purposes and during times when prices are rising. 

Weighted average cost 

This method works by calculating the average cost of all your inventory items. 

Specific identification 

Specific identification tracks the cost of each and every item in your inventory, which is ideal if your business is dealing with high-value items. 

Just-in-time (JIT)

This is a strategy where inventory is ordered and received just before it’s actually needed. This helps to lessen your holding costs and minimize your business’ wastage. 

Streamline your FIFO inventory management with Katana 

Managing your inventory can feel like a daunting task, especially if you’re staring at hundreds of boxes that haven’t previously been sorted through or labeled. 

Luckily, Katana’s inventory management software offers tools for helping you run your business more smoothly. Katana offers real-time tracking, integration with your other systems, and reorder points — all of which help you to implement a FIFO strategy. 

Ready to possess even more control over your inventory? Get a demo of Katana today and start reaping the rewards.