FIFO: simple explanation – IONOS

The FIFO method is used to store and manage goods. According to this principle, the goods are picked following the order in which they were added to the stock.

What is the FIFO method?¶

FIFO is the acronym for the expression “First In, First Out”, which designates a method of regulating storage for various goods. The FIFO principle is to determine the picking order of the goods in order to better calculate the stocks accordingly. The expression “First in, first out” could be a literal translation of “First In, First Out”. The FIFO process consists in respecting a certain chronological order. According to the FIFO method, the products that have been in stock the longest, because they have been added first, are also the first to be picked. It is an important tool to prevent wear and tear, especially for the perishable goods sector.

How does the “First In, First Out” principle work?

Not all sectors of activity depend on the FIFO process and, in certain areas, other methods may also prove to be more judicious. However, the principle « First In, First Out » is particularly important for the sale foodstuffs, medicines, other medical devices or even certain bulk products. You may even be using this method in your fridge: if you push your yoghurt pots to the bottom as you buy more, they will eventually pass their expiration date and, in the worst case, cases, you will have to throw them away. With the “First In, First Out” method, the oldest products are the first to be used. Economically, the FIFO method works the same way, but on a much larger scale.

What are the requirements for applying the FIFO process?¶

As a general rule, the FIFO principle therefore makes sense; but it is not always easy to apply. To apply the FIFO method, it is important to have well-designed storage and accounting systems. It is necessary that the exact state of the stock is always clear to respect the good chronological order between the entry of the goods (or their production strictly speaking) and their exit. It is also important to train and raise awareness among all employees in this regard.

On a larger scale, it is recommended to opt for viable storage systems adapted to the FIFO method. Warehouses with high or dynamic racks, equipped with an entrance and an exit, or even silos lend themselves ideally to the FIFO method and facilitate the work of the personnel concerned.

What are the advantages of the FIFO method?¶

Properly designed and executed, the FIFO process offers many advantages. It significantly reduces wear, perishability and obsolescence of the different products, which is also accompanied by a reduction in costs. The FIFO principle also favors the monitoring of expiry dates. The use of available storage space is optimal, the management of the supply chain is improved, the overview of the total stock is guaranteed, and it is often possible to physically separate incoming goods from picked goods. The “First In, First Out” method is easy to learn and apply.

What are the different FIFO methods?¶

The FIFO principle also plays an important role in the accounting of a company. Indeed, the stock is considered as part of the capital of a company; it must therefore be accounted for accordingly. According to the FIFO principle, the goods are picked in the chronological order of their arrival. To calculate the valuation of stocks, it is possible to use the permanent FIFO principle or the periodic FIFO principle.

The permanent FIFO principle¶

As part of the permanent FIFO principle, the stock is recalculated after each purchase or sale. If this FIFO method is rather expensive, it reflects very precisely the evolution of the activity and allows you to monitor your income, your expenses and the state of your stock on an ongoing basis.

Let’s take a closer look at the permanent FIFO principle usingan example. To do this, let’s imagine a company that produces confectionery and for this purpose uses sugar. Supply and withdrawal activities are recorded in a table. This looks like this:

According to the FIFO principle, the stocks received first are also those which are taken first. The first goods issue in its entirety was therefore still taken from the starting stock at €2, for a total value of €220. On the other hand, for the second goods issue, the situation becomes a little more complicated. According to the FIFO method, the rest of the starting stock at €2 has been exhausted. To this should be added the whole of the first delivery at €1, and part of the second delivery at €4. The total result then corresponds to €320.

On the other hand, the ending stock can only be made up of the second delivery at €4, which gives it a value of €560. Material consumption is therefore made up of the two items entitled “Issue of goods”, and amounts to €540.

The periodic FIFO principle¶

The periodic FIFO principle does not take into account each individual change; the necessary calculations are made at the end of a period, ie at the end of the financial year. This FIFO method is based on the prices of the last goods receipt. It is certainly a little simpler, but its results are also less precise. If we take the example above, the periodic FIFO principle looks like this:

Since the FIFO method is applied, it is clear that the ending stock can only be derived from the last delivery. It is therefore valued at €4/kg, for a total of €560. Now, the material costs should also be evaluated using the following formula:

valuation of the starting stock + valuation of the entries – valuation of the ending stock.

In the context of our example, this translates into the following operation: 200 x €2 + 100 x €1 + 150 x €4 – €560 = €540. To value the different issues of goods, this value should be divided by the total of these issues: 540 € divided by 310 kg corresponds approximately to 1.74 €/kg.

What is the difference between FIFO and LIFO methods?¶

Alongside the FIFO process, there is also the LIFO method, or  » [Last In, First Out] « . With it, the items added last are the first to be picked. This principle facilitates the work, because it avoids having to move the goods. It optimizes the available storage space, offering a considerable advantage to small online shops and their distribution policy. At the time of the calculation, the LIFO method can be interesting by making it possible to deduct from the turnover goods purchased at a high price. It is not really suitable for products with an expiry date.