Quick Summary<\/strong>:\u00a0<\/p>\r\n\r\n\r\n\r\n Every business that works with an inventory needs a reliable way to track it and its costs. The First\u00a0In\u00a0First Out (FIFO) method is the most widely used method to do this. This post will walk you through everything you should know about this inventory management method.<\/em>\u00a0<\/p>\r\n\r\n\r\n\r\n You'll walk away knowing: <\/em>\u00a0<\/p>\r\n\r\n\r\n\r\n From an accounting perspective, not having a clearly defined method will result in everything from your stock valuations and tax calculations to, most importantly, profit margins being off. This is precisely why inventory valuation methods like FIFO exist.<\/p>\r\n FIFO, short for First\u00a0In\u00a0First Out, plays a dual role in the context of inventories. The first is inventory management<\/a>, where it is used to control how businesses that deal in perishable goods or those with limited shelf lives or expiry dates\u00a0clear\u00a0their inventory, i.e., the oldest items\u00a0are sold first.<\/p>\r\n The second is for inventory valuation from an accounting perspective. Let’s look at each in detail.<\/p>\r\n \u00a0of national food sales in South Africa run through supermarkets, channels where FIFO is operationally essential.\u00a0<\/p>\r\n Source:PMC<\/a> <\/p>\r\n \r\n <\/div>\r\n From an operational standpoint, FIFO is a stock movement strategy where the oldest goods in the inventory are sold first.<\/p>\r\n This strategy is mostly used in supermarkets, pharmacies, food wholesalers, and similar businesses in South Africa that need to physically rotate their stock to<\/p>\r\n The next time you are at a supermarket, pay close attention to how each product is stacked. You will notice that the items placed in front expire sooner than the ones placed far back.<\/p>\r\n If you ever wondered why your mother or grandmother always told you to pick something from the back of the shelf, this is why. As a business, following the FIFO method always ensures that your inventory flows in a way that minimizes waste and keeps stock fresh.<\/p>\r\n For businesses managing multiple sales channels or warehouses, a well-configured order management system<\/a> can automatically enforce FIFO rules during stock allocation<\/p>\r\n From the perspective of accounting, the FIFO method is used to calculate three very important financial values for your business, such as:<\/p>\r\n For the uninitiated, Cost of Goods Sold, or COGS for short, is the total cost of the inventory a business has sold during a given period. Under the FIFO method, it is calculated by assigning the cost of the oldest batch to each unit sold first. Once that batch is fully consumed, the cost of the next oldest is used, and so on.<\/p>\r\n Now, since FIFO uses older costs to calculate COGS (as opposed to the latest figures that are\u00a0almost always\u00a0higher due to inflation), on paper, it makes your business appear even more profitable than it is. On the\u00a0flip side, this also means higher taxable income.<\/p>\r\n Since the oldest inventory is assumed to be sold first, the stock that remains is now valued at the most recent purchase prices. As a result, this means your ending inventory value is closer to the current market value.<\/p>\r\n Which in turn gives you a more realistic idea of what your stock is actually worth today.<\/p>\r\n Quick Fact<\/em><\/strong>\u00a0The FIFO method is recognized by the\u00a0International Financial Reporting Standards (IFRS)<\/a>, which over 140 countries follow, making it the most used inventory valuation method today.<\/p>\r\n To be clear, FIFO is not a metric in itself, and there is no direct calculation for FIFO. It is, in fact, a method used to calculate the cost of goods sold (COGS). Now, the formula for COGS is always constant, which is:<\/p>\r\n COGS = Starting Inventory + Purchases \u2212 Ending Inventory,<\/strong><\/p>\r\n Where:<\/strong><\/p>\r\n Now, the first two parameters are straightforward. The former (starting inventory) is the figure that comes directly from the closing inventory value of the previous period. The latter (purchases) is what you paid for everything you brought in.<\/p>\r\n What using the FIFO method does is influence the final value of the equation, i.e., the ending inventory. The process to value your inventory under the FIFO method goes like this:<\/p>\r\n Let\u2019s assume a South African business purchased:<\/p>\r\n This makes the starting inventory value<\/p>\r\n (100*R10) + (100*R12) + (100*R15)<\/strong> = R1000 + R1200 + R1500\u00a0<\/strong> =\u00a0R3700<\/strong><\/p>\r\n Now\u00a0lets\u00a0assume the business has sold 150 units in total. Under the FIFO method of inventory valuation, the assumption will be as follows:<\/p>\r\n Now,\u00a0let\u2019s\u00a0calculate the value of the ending inventory. As of now, 150 units\u00a0remain\u00a0(50 units at R12 and 100 units at R15. The ending value now becomes: Now, if we plug these into the formula: Manage inventory, pricing, and valuation across multiple batches without guesswork using VasyERP.\u00a0<\/p>\r\n \r\n
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Inventory management is a complex process in itself, especially when perishable goods are involved. Add to this the fact that input costs per batch can vary, and the complexity only increases.<\/p>\r\n<\/span>What is\u00a0the\u00a0FIFO Method?<\/span><\/h2>\r\n
<\/span>How FIFO Works in Inventory Management in South Africa?<\/span><\/h2>\r\n
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<\/span>FIFO in Accounting: How It Affects Your Numbers<\/span><\/h2>\r\n
Cost of Goods Sold<\/h3>\r\n
Profit Margins<\/strong><\/h3>\r\n
The Inventory’s Value<\/strong><\/h3>\r\n
<\/span>How to Compute FIFO?<\/span><\/h2>\r\n
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Since, under the FIFO method of inventory valuation, we assume all the older goods are sold first, you value the ending inventory at the cost of your most recently purchased batches.<\/p>\r\n<\/span>FIFO Method of Inventory Valuation<\/span><\/h2>\r\n
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<\/li>\r\n<\/span>Example of First in, First Out in Practice<\/span><\/h2>\r\n
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(50*R12) + (100*R15) = 600 + 1500 = R2100\u00a0<\/strong><\/p>\r\n
COGS = Starting Inventory + Purchases \u2212 Ending Inventory, we get:\u00a0\u00a0<\/strong> COGS = 3700 \u2212 2100 =\u00a0R1600\u00a0<\/strong><\/p>\r\n