Selling goods requires a lot of tracking. Business owners need to have a solid grasp of the products they need and ensure that they have enough inventory to fill orders and requests as needed. Maintaining all of this information can be very challenging, but it is necessary for any business that sells goods.
FIFO, which stands for “First-In, First Out” is one of the most commonly used methods for maintaining raw inputs, getting inventory out of the door, and calculating costs. While the concept is simple, ensuring operational efficiency is often difficult, especially within large companies or businesses with a wide variety of raw materials and product offerings. However, incorporating the right kind of technology can make using FIFO easier and more effective, often saving companies time and money.
What is FIFO, and How Is It Calculated?
When maintaining inventory, selling the oldest products first makes sense for a lot of reasons. Using the oldest goods and raw materials first keeps things fresh and current. From a cost perspective, using the FIFO method allows the company to ensure that products in inventory are a better reflection of market value. Finally, for companies that rely on perishable items, utilizing the FIFO method eliminates waste and potential spoilage.
Calculating FIFO is straightforward. First, you find the Cost of Goods Sold (COGS) for your oldest inventory. Inventory sold includes not only the purchasing cost of the raw materials but also the cost to make the good, including things like:
- Manufacturing overhead
Once you have calculated that cost, you simply multiply the cost by the amount of inventory sold.
Costs often fluctuate. As a result, you may need to do this type of calculation in batches or based on a set amount of time. To have accurate cost numbers, you must take all of these fluctuations into account.
Consider a simple example. Imagine you sold 100 items over the course of one week. Of those, 75 items could be made from raw materials that cost $3 per unit. The remaining 25 cost $3.50 per unit. In that situation, you must adjust so that the true cost of each item is calculated—75 units at $3 and 25 units at $3.50. Assigning a flat $3 for each unit would create an inaccurate cost, which is off by $12.50. While the $12.50 in this example may not seem like a lot of money, if you start using incorrect information like this on a larger scale, particularly if used over time, it can add up quickly.
You should also note that only those goods that have been sold should be included in COGS. If the product has not yet been sold, then it should not be included yet. Any items that have not yet sold will remain as an “inventory” asset on the books.
The Difference Between FIFO and LIFO and Why It Matters
LIFO stands for “Last-in, First-Out.” It is an alternative inventory method that assumes that the last products in the company’s inventory were sold first. Under this model, the latest cost numbers used to produce inventory should be considered on the books.
The inventory method that you use for your company will have an effect on how your profits are calculated. That, in turn, affects the amount of income taxes that a company will have to pay on those profits.
Whatever inventory method you use is often not connected to how the physical goods move in your business. For some companies, their physical inventory will use FIFO, regardless of whether they use FIFO or LIFO to track the costs (and profits) associated with selling those goods.
LIFO and FIFO: Which Option is Better?
FIFO is generally considered a better inventory tracking method. It is easier to understand and implement, and it is more transparent. Tracking costs in a way that mimics the natural flow of inventory is generally assumed to be more accurate as well. FIFO also usually creates higher profits on the books, making it more attractive to investors.
LIFO, in contrast, could have the unintended result of having older inventory stay on the books forever. The result is often that the older inventory will never reflect market values, either. LIFO statements are also much easier to manipulate, which calls into question their accuracy and reliability. Nonetheless, LIFO is still often used within businesses that do not have perishable goods.
It is worth noting that changing from LIFO to FIFO will often increase taxable income. This is generally the result of comparing today’s profits to the oldest costs, but that may not always be the case.
How is FIFO Used in Practice?
Retail accounting is often more complex compared to other types of businesses because of the need to track inventory closely. In retail, there are few service components that you need to consider as part of your product matrix or offerings. Instead, everything relies on the difference between the cost of making a product and the price tag of that good when it is finally sold.
Accuracy is critical to getting good information in retail companies. If the inventory is not tracked accurately, then you have no way to measure how well things are doing—from any angle, such as marketing, maintenance, staffing, etc.
Inventory tracking will generally happen in one of two ways in the retail industry. The company can periodically take a physical inventory of the goods available, such as every month, quarter, or year. These periodic updates allow you to update your COGS for that period.
Alternatively, retailers can track inventory perpetually so that inventory is constantly updated and maintained. This method requires increased reliance on technology, specifically systems that not only track regular inventory but also decrease items in stock when sold at the time of sale and add items when they are produced and ready to be sold.
Although it might take some initial work to set up or establish, once the inventory tracking system is in place, it manages itself. It also significantly decreases physical worker requirements because there are either no or far fewer physical inventory counts.
The healthcare industry mixes both inventory and services to provide a positive customer experience. Inventory is generally in the form of items used to provide services, but it can also include things like medicine and general care supplies. The healthcare industry will also use a concept similar to FIFO—FEFO, which stands for “First-Expired, First Out.” This concept operates the same way, but focuses on using perishable goods first, so they are not used after their expiration date.
Like a retail business, the healthcare industry needs to be able to track inventory to know how much specific items are costing the business. While less dependent on products, those items are still a necessary part of being able to provide services to patients.
Perpetual tracking may not be an option for some healthcare facilities. Instead, tracking at the end of each day, week, or month might be a better option. Emergency situations certainly do not lend themselves well to being able to input inventory information into a database or anything similar, so adjustments to the perpetual model may be necessary.
Using Technology to Accurately Track Inventory with the FIFO Method
Tracking costs of goods sold requires accuracy and virtually constant access to information. If businesses want to have consistent information that is reliable, using technology is the best way to accomplish that goal, particularly when dealing with a large amount of inventory.
The type of information you will need to track includes:
- All purchases that in any way related to inventory
- Finished products in inventory at any given time
- Products sold to clients
- Inventory that has expired or has become obsolete
- Cost fluctuations in raw materials
Various other information pertaining to maintaining and accessing inventory (such as location, for example) might also be useful in some situations as well.
Technology can be extremely helpful to train and maintain this type of information. Digital experiences are helpful for both employees and customers—and Ombori can help provide this type of solution.
Using Ombori to Assist with Inventory Tracking and Maintenance
Ombori can help with curbside, online ordering, appointment setting, and a lot more. By incorporating Ombori services with your existing tracking and technology, you can take inventory management to the next level, increasing access and accuracy. Learn more about how Ombori can help with inventory maintenance and control by contacting our team.