What is FIFO
FIFO (First In, First Out) is an inventory management method and accounting principle that assumes the items purchased or produced first are sold or used first. In this system, the oldest inventory items are recorded as sold before newer ones, which helps determine the cost of goods sold (COGS) and remaining inventory value.
The first in, first out, aka FIFO (pronounced FIE-foe), accounting method assumes that sellable assets, such as inventory, raw materials, or components acquired first were sold first. That is, the oldest merchandise is sold first, with its associated costs being used to determine profitability. (In contrast, LIFO – last in, first out – assumes the newest inventory is the first to sell.)
In reality, sales patterns don’t usually follow this simple assumption. You’ll often sell a mix of new and older merchandise.
But FIFO has to do with how the cost of that merchandise is calculated, with the older costs being applied before the newer. This is often different due to inflation, which causes more recent inventory typically to cost more than older inventory.
As a result, profits may be higher with FIFO than with LIFO.
FIFO in practice
Let’s pretend that your store purchased three shipments of stock in the last three months. The summary looks like this:
Month Cost of Inventory Retail Price June $1000 $4000 July $2000 $4000 August $3000 $4000
Using FIFO, when that first shipment worth $4,000 sold, it is assumed to be the merchandise from June, which cost $1,000, leaving you with $3,000 profit. The next shipment to sell would be the July lot under FIFO – since it is not the oldest once the June items are sold - leaving you with $2,000 profit.
This assumption that inventory is sold according to age, which works well for companies with seasonal inventories, such as clothing, housewares, and furniture, doesn’t necessarily match up well with companies that routinely introduce new merchandise, such as in the technology space.
Unlike with LIFO, which tends to minimize profits by applying the most recent (and often higher) costs when calculating company profits, FIFO may result in higher profits, thanks to the practice of assuming product costs are older and lower.
FIFO FAQ
What is the meaning FIFO?
FIFO stands for First In, First Out. It is a method for organizing and managing data that is based on the principle that the item that is stored first is the item that is retrieved first. In other words, the oldest item in the system is the first one to be processed.
What is FIFO inventory method?
FIFO stands for “First In, First Out” and is an inventory accounting method used to track the cost of goods sold. This method assumes that the first items purchased (or produced) are the first items sold and that the cost of those items is the cost of goods sold. This method is used to ensure that the costs associated with inventory are accurately reflected in a company’s financial statements.
What is the difference between FIFO and LIFO?
FIFO (First In, First Out) is an inventory management method that prioritizes the sale of items that have been in a company's inventory for the longest amount of time. This method is used when the cost of goods is based on their age. LIFO (Last In, First Out) is an inventory management method that prioritizes the sale of items that have been in a company's inventory for the shortest amount of time. This method is used when the cost of goods is based on their freshness.
? Definition and Guide - Shopify (2024))
