In which inventory costing method is the newest inventory being sold first?

When Susan first opened her pet supply store, she quickly discovered her most high-demand, fastest-selling products that generated the highest profit margins.

It turned out that the vegan pumpkin dog treats were a huge hit and bringing in favorable revenue. But when it was time to replenish inventory, her supplier had increased prices.

Though some products are more vulnerable to fluctuating price changes, dealing with inflation when restocking inventory is inevitable. 

But no matter what you sell, keeping track of inventory value over time is essential. So how should a brand keep track of fluctuating inventory value over time?

To ensure accurate inventory records, one of the most common methods is FIFO (first-in, first-out), which assumes the oldest inventory was sold first and the value is calculated accordingly.

Read on for a deeper dive on how FIFO works, how to calculate it, some examples, and additional information on how to choose the right inventory valuation for your business.

What is the FIFO method?

FIFO stands for first in, first out, an easy-to-understand inventory valuation method that assumes that goods purchased or produced first are sold first. In theory, this means the oldest inventory gets shipped out to customers before newer inventory. 

To calculate the value of ending inventory, the cost of goods sold (COGS) of the oldest inventory is used to determine the value of ending inventory, despite any recent changes in costs.

How the FIFO inventory valuation method works

Since ecommerce inventory is considered an asset, you are responsible for calculating COGS at the end of the accounting period or fiscal year. Ending inventory value impacts your balance sheets and inventory write-offs.

Due to inflation, the more recent inventory typically costs more than older inventory. With the FIFO method, since the lower value of goods are sold first, the ending inventory tends to be worth a greater value.

Additionally, any inventory left over at the end of the financial year does not affect cost of goods sold (COGS).

It’s important to note that FIFO is designed for inventory accounting purposes and provides a simple formula to calculate the value of ending inventory. But in many cases, what’s received first isn’t always necessarily sold and fulfilled first.

However, if you sell items that have a short shelf-life, are perishable, or tend to go obsolete quickly, the FIFO method provides a dual advantage of proper inventory management and an easy method for calculating ending inventory value.

Calculating inventory value that matches the natural flow of inventory throughout your supply chain, you’re able to track and regulate quality and offset the risk of high holding costs for storing inventory that is obsolete or no longer sellable (also known at dead stock).

Though it’s the easiest and most common valuation method, the downside of using the FIFO method is it can cause major discrepancies when COGS increases significantly.

If product costs triple but accountants use values from months or years back, profits will take a hit. It also does not offer any tax advantages unless prices are falling.

Examples of calculating inventory using FIFO

According to the FIFO cost flow assumption, you use the cost of the beginning inventory and multiply the COGS by the amount of inventory sold. 

Let’s revisit Susan’s pet supply store. Originally, Susan bought 80 boxes of vegan pumpkin dog treats at $3 each. Then, then she bought 150 more boxes at a cost of $4 each, since the supplier’s price went up.

• Susan now has 230 boxes of dog treats in stock.
• Of these, 100 boxes of dog treats have been sold.

In her balance sheet, the total cost of goods she sold above (100 boxes) would be:

COGS = (The Number of Original Units x Their Value) + (Remaining Units From the Second Purchase x Their Value)

COGS = (80 x $3) + (20 x $4) = $320

Notice that the cost of the oldest inventory items are used first in the COGS calculations (the initial purchase of 80 boxes at $3/each) and the remaining 20 boxes use the second purchase cost of $4/each. The value of the remaining or ending inventory (130 boxes) is then calculated:

Ending Inventory Value = Remaining Units x Their Value

Ending Inventory Value = 130 x $4 =  $520

Consider another example of a manufacturer producing the dog treats. The company produced 2 batches of the dog-loving pumpkin treats with the following specifications:

Of the 60 total units in stock, if they were to sell 20 units, under FIFO it would assume that 100% of Batch 1 (10 units at $30/each) and 10 units from Batch 2 (the remaining 10 units at $40/each) were sold. The COGS would be calculated accordingly:

COGS = (The Number of Original Units x Their Value) + (Remaining Units From the Second Purchase x Their Value) 

COGS = (10 x $30) + (10 x $40)  = $700  

And, the ending inventory value is calculated by adding the value of the 40 remaining units of Batch 2.

Ending Inventory Value = Remaining Units x Their Value

Ending Inventory Value = (40 x $40) = $1,600

What’s the difference between FIFO vs. LIFO?

LIFO stands for last in, first out, which assumes goods purchased or produced last are sold first (and the inventory that was most recently purchased will be sent to customers before the oldest inventory). It is an alternative valuation method and is only legally used by US-based businesses.

FIFO, on the other hand, is the most common inventory valuation method in most countries, accepted by IFRS International Financial Reporting Standards Foundation (IRFS) regulations.

Businesses that use the FIFO method will record the original COGS in their income statement. With LIFO, it’s the most recent inventory costs that are recorded first.

If COGS are higher and profits are lower, businesses will pay less in taxes when using LIFO. Of course, the IRA isn’t in favor of the LIFO method as it results in lower income tax.

However, it does make more sense for some businesses (a great example is the auto dealership industry). For this reason, the IRS does allow the use of the LIFO method as long as you file an application called Form 970.  

Compared to LIFO, FIFO is considered to be the more transparent and accurate method. It also tends to result in higher gross profit than LIFO.

What method of inventory management should you use?

Of course, you should consult with an accountant but the FIFO method is often recommended for inventory valuation purposes.

If you sell a product that requires fulfilling older inventory first for quality purposes (especially if you sell perishables and other types of time-sensitive goods), the FIFO method will follow the natural flow of inventory, providing accurate numbers. 

For retailers dealing with food items, cosmetics, or electronics, for example, the FIFO method helps to avoid having to write off or write down inventory from the oldest received, in case demand is slower-moving than expected.

Additionally, it ensures that you are more likely to use the actual price you paid for the goods in your income statements, making the calculations more accurate and simple, and record-keeping much easier. 

FIFO is also the option you want to choose if you wish to avoid having your books placed under scrutiny by the IRS (tax authorities), or if you are running a business outside of the US.

Leave inventory management to the pros

ShipBob’s tech-enabled retail fulfillment solution is designed for fast-growing B2B ecommerce and direct-to-consumer brands. 

For inventory tracking purposes and accurate fulfillment, ShipBob uses a lot tracking system that includes a lot feature, allowing you to separate items based on their lot numbers.

When you send us a lot item, it will not be sold with other non-lot items, or other lots of the same SKU. 

Following the FIFO logic, ShipBob is able to identify shelves that contain items with an expiry date first and always ship the nearest expiring lot date first.

If you have items stored in different bins — one with no lot date and one with a lot date — we will always ship the one updated with a lot date first.

“We also have easy ways to manage subscription orders as well as expiration dates and lot numbers, so inventory goes in First In, First Out (FIFO).”

Leonie Lynch, Founder & CEO of Juspy, a ShipBob merchant

Our premium fulfillment software’s built-in inventory management tools also help you to:

• Keep track of inventory in real time.
• Easily update and manage SKUs.
• View sales trends to forecast demand.
• And much more.

With this level of visibility, you can optimize inventory levels to keep carrying costs at a minimum while avoiding stockouts.

We also offer Develop API to enable a custom-built inventory management solution that ties into your accounting platform, to keep financial statements up-to-date, even when order volumes are skyrocketing.

“We utilize ShipBob’s Inventory API, which allows us to programmatically retrieve real-time data on how many units of each product are currently stored at ShipBob’s warehouses. We currently use this API to generate custom reports to tie this inventory data into our accounting platforms.”

Waveform Lighting Team

Interested to see our fulfillment solution in action? Check out a 3D behind the scenes look at how ShipBob operates:

Whether you’re a business owner or an ecommerce operations manager, ShipBob can help you expand your distribution logistics network and manage inventory flow throughout your entire ecommerce supply chain without being involved in the day-to-day logistics operations.

To grow your brand with ShipBob, get the process started by requesting custom pricing.

Request Fulfillment Pricing

FIFO FAQs

Here are answers to the most common questions about the FIFO inventory method.