What is FIFO? Uncover the Strategy to Calculate FIFO

What Does FIFO Stand for?

The full form of FIFO is First In First Out, according to which an item that comes first in inventory will be sold out first. This strategy helps to avail the high profit with less waste. It is because a shopkeeper can sell the old item before its expiry date.

What Is FIFO? Lets Understand the Basic Method?

The FIFO method is a procedure of cost flow assumption in the sold goods cost calculation. As per the FIFO, the oldest product will be sold first. You can easily understand the FIFO meaning with a storekeeper. This is usually applicable to food and beverages businesses to ensure products are sold out before their expiry date. With this, there is less waste and higher profit. It will be handy to calculate the cost of those old products.

How Does FIFO Work?

In FIFO, new items are continuously added to inventory while old items are taken out for selling. In this way, old items sell out first after new items sell. Like this, it ensures that old goods closer to their outmoded or expiry date sell out first.

In accounting, the significant utilization of FIFO is inventory value and goods sold (COGS) calculation cost. The concept of FIFO is simple. The selling price of goods is always based on the cost of already stock or available old items. The value of ending inventory depends on the latest purchased item.

How Do You Calculate FIFO?

Now you get a good idea and uncover the answer to what is FIFO. It’s time to uncover the answer to how you can calculate FIFO. Calculating the FIFO value is crucial for business holders. Divide the oldest items cost in inventory by the total number of purchased units. In this way, you will get the FIFO unit cost per item. This value is a useful factor in the remaining inventory value calculation.

Let us understand the FIFO calculation for the cost of goods sold through an example. Suppose a business buys 100 units of product X at $20 each. Out of this, 50 units are in inventory, and 50 units are sold out.

Now, the cost of FIFO will be as follow

FIFO cost = (50 x $20) / 100 = $10

This is a simple method to calculate the FIFO cost.

What Are the Advantages of FIFO?

1. Current Inventory Data

The FIFO method always provides the correct analysis of what your beginning inventory is costing your business. It also offers real-time assessment of the profession. Sellers can decide the value of their on-hand inventory from the latest generated products. So, it is easy to get the alignment match of inventory price to the current market price. Professionals can get an idea of the final replacement cost.

Companies can easily calculate COGS and the company’s gross margin. It helps the company to get a profit idea.

2. Modernize Business System

Most of the FIFO software is highly compatible. There are many accounting softwares available for the FIFO method of accounting. Also, professionals can use FIFO inventory invoice templates to accelerate their work. Businesses acquire new positions through incorporating FIFO methods. It replaces the old manual system with advanced solutions. It prevents the chances of obsolete products. Thus, a company can get maximum profit with the lowest loss and product waste.

3. Increase the Business Value to Buyers

The cost of goods is inclined to hike over time. That is the reason FIFO calculates higher profits. Ultimately, your business will be more valued by potential customers. You can even check the profit difference between the current selling product and business cost or earlier inventory. The FIFO inventory valuation method offers benefits to the business.

4. Accurate Margins

With increasing inventory prices, your FIFO always shows the correct net profit. It prevents the perplexing situation in financial reporting. This is because the cost of sales value is accurate for profit reporting. Also, there are less chances of mistakes because of the natural flow of inventory.

5. Companies Accurate Picture

The FIFO strategy always gives an accurate financial scenario for the company. It is hard to manipulate the financial statement and easy to do future planning for the company. Also, the inflation impact declined. The reason behind it is the assumption that the cost of purchasing new inventory is greater than the buying price of old inventory.

What Businesses Need to Choose FIFO?

There are different kinds of businesses that could opt for FIFO. However, there are certain businesses where FIFO is very helpful to consider. These are as follows.

• Business where inventory quantity is determined at the end of each period.
• Storekeepers who sell perishable goods need to sell old items first.
• Businesses doing international trade under International Financial Accounting Standards (IFRS).

FIFO vs. LIFO

LIFO stands for Last In First Out and is another inventory method to calculate the goods profit. In LIFO, the most recent inventory item is sold out first, and older items are sold out later. However, this method is beneficial when the products are out of obsolete range. LIFO is majorly useful for jewelry, retailers, large auto dealers, and oil companies.

FIFO and LIFO are highly different and opposite to each other. Both methods have different unit-sold assumptions. To understand LIFO vs FIFO let’s understand the following points.

Accounting Calculations

The financial gain and loss calculation is different for both inventory methods. FIFO always allows firms to value the remaining stock of products at the closest market price.

In LIFO, companies are free to give value to more recent stock which is higher than older goods. In inventory calculation, businesses charge costs and revenues at the same time. LIFO works well in this condition.

Products

FIFO is much more suitable for businesses that sell perishable products like food and beverages. LIFO is more suitable for products that remain unaffected by time. It includes jewelry, auto parts, automobiles, car retailers, and oil companies.

Inventory

In FIFO, businesses continuously sell old products from inventory. On the other hand, LIFO’s older products remain in inventory, and the main focus is on new products.

Timing is the major factor that differentiates the cost of FIFO and LIFO.

What Factors to Consider When Choosing FIFO and LIFO?

Professionals must keep a note of the following points when choosing FIFO and LIFO.

Inflation: LIFO leads to tax savings with lower profit reporting. So, it is beneficial during the inflationary period.

Product Shelf Life: The FIFO method is most suitable where the shelf life of products is low, like food and beverage items. It ensures superlative product quality.

Financial reporting: Making a justification between FIFO and LIFO can also affect financial statements. Professionals must notice the implication of both methods on their financial reporting requirements.

Industry Practice: Companies should always deal with industry norms and practices.

FIFO Example

Let’s understand the example of FIFO with consideration of assumed data. A shopkeeper purchases t-shirts at different prices on different dates.

Out of the total units, we have sold 250 units of t-shirts. However, we have no idea that 250 items were sold from that unit. So, we will use the assumption of cost flow. The COGS calculation will be as follows.

COGS (Cost Of Goods Sold) = (number of original units x their cost) + (remaining units from the second purchase x their cost)

(200 x $10) + (50 x $20) = 2000 + 1000 = $3000

Shopkeeper has used the old price of the inventory item, which was $10 for 200 units. For the remaining 50 units, the cost is $30.

Now, for ending inventory calculation, we need to use the formula.

Ending inventory value = Remaining units x their value

Ending inventory = (100 x $20) + (225 x $30) = $8750

Last Words

Hope you got the right answer to what is FIFO? It is a good process to track your old items and sell them before their expiration date. FIFO is the best method for grocery stores and businesses to make your inventory flow smoothly. Meanwhile, you can also incorporate the right template for your inventory and the FIFO method.

Moon Invoice offers numerous inventory templates to simplify your work. It’s one place for multiple solutions to your needs. Are you looking to automate your work? Download our App Now.

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