Definition
First-In, First-Out (FIFO) is an inventory management and accounting method where goods purchased or produced earliest are sold, used, or disposed of first, ensuring that the oldest inventory leaves stock before newer items. FIFO assumes that businesses naturally sell their oldest products first, which closely mirrors actual inventory flow for most operations and proves essential for managing perishable goods, preventing obsolescence, and maintaining inventory freshness.
Understanding FIFO
FIFO represents both a physical inventory management practice and an accounting valuation method. In warehouse operations, FIFO means organizing storage so the first products to arrive become the first products picked for orders, minimizing waste from expiration or obsolescence. For accounting purposes, FIFO assumes the cost of the oldest inventory gets recorded as cost of goods sold while newer inventory remains valued on the balance sheet at more recent prices.
This method aligns naturally with how most businesses operate. Food companies, pharmaceutical manufacturers, and retailers handling perishable goods implement FIFO to prevent spoilage and meet regulatory requirements. Even businesses selling non-perishable products often follow FIFO principles to avoid inventory becoming outdated or technologically obsolete. The straightforward logic—sell what arrived first—makes FIFO intuitive for warehouse staff and easy to implement across operations.
FIFO is accepted under International Financial Reporting Standards, making it the only option for companies operating globally. During inflationary periods, FIFO typically results in lower cost of goods sold (since older, cheaper inventory gets expensed first), leading to higher reported profits and consequently higher tax liability compared to LIFO. However, this also means the inventory values on balance sheets more accurately reflect current market prices.
Key FIFO Characteristics
- Physical Flow Alignment: Matches actual movement of goods in most businesses where older inventory naturally gets sold before newer stock
- Inventory Freshness: Prevents product expiration, spoilage, or obsolescence by prioritizing movement of oldest items first
- Simple Implementation: Straightforward concept that warehouse workers easily understand and execute without complex procedures
- Higher Reported Income: During inflation, lower COGS from older inventory prices results in higher gross profit and taxable income
- Accurate Valuation: Balance sheet inventory reflects recent purchase prices, providing realistic asset valuation closer to current market values
FIFO in Practice
A grocery distributor receives shipments of organic milk weekly. Using FIFO principles, warehouse staff organize cooler storage with newest deliveries placed behind existing stock. When retailers order milk, pickers always take products from the front—the oldest milk with earliest expiration dates—ensuring customers receive the freshest possible product while minimizing waste from expired inventory. The accounting system automatically applies FIFO costing, recording the cost of the oldest milk inventory as expense when sold, while newer milk purchases remain valued as inventory assets on the balance sheet.
Related Concepts
- LIFO (Last-In, First-Out): Alternative accounting method where newest inventory costs are expensed first, used mainly in the US for tax advantages during inflation
- FEFO (First-Expired, First-Out): Variant that prioritizes items by expiration date rather than arrival date, critical for pharmaceuticals and food with varying shelf lives
- Inventory Turnover: Metric measuring how quickly inventory sells, typically higher under FIFO since older stock moves first
- Cost of Goods Sold (COGS): Accounting category where FIFO assigns the cost of oldest inventory when recording sales expenses
- WMS (Warehouse Management System) : Software that enforces FIFO through location management, directed picking, and automated inventory rotation
