First in first out (FIFO) warehousing means exactly what it sounds like. It’s an inventory control method in which the first items to come into the warehouse are the first items to leave. Similar to the service industry concept of “first come, first served”, the FIFO method focuses on products, not people.
The logic behind first in first out is simple: The items you received first are the items you’ve held longest and therefore closest to obsolescence or expiry. In order to avoid worthless inventory, business owners move these products before they can’t be sold.
You want to know something else that’s interesting? The FIFO method applies to both warehouse management and accounting where it’s used as an inventory valuation method. With accurate inventory valuation methods, a company’s financial statements reflect reality as accurately as possible. As a leader, you can then make smart decisions. It’s a line item that smart investors pay attention to as well.
Before we take a close look at FIFO warehousing, let’s differentiate between the different methods of inventory management.
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How Many Different Ways Can You Manage Your Inventory?
It’s a pain in the neck, but you’ve got to carefully manage your inventory. Your inventory is your company’s lifeblood. Fortunately, businesses have been managing inventory for so long that there are established methods that fall into two main schools of thought:
- Periodic inventory accounting system
- Perpetual inventory accounting system
In the periodic system, the business records sales in real-time, but checks the stock at specific intervals. At minimum, the stock should be checked annually, but businesses can conduct a manual count on a monthly or quarterly basis.
On the other hand, the perpetual system keeps tabs on a business’s inventory in real-time. The system updates the inventory amount each time a product sells. Of course, you’ll need a warehouse management system to implement this sort of real-time updating.
There are four inventory valuation methods used under the perpetual system:
- First in, first out (FIFO) accounting
- Last in, first out (LIFO) accounting
- Highest in, first out (HIFO) accounting
- Average cost / weighted average cost accounting
Inventory Valuation Method
First products to arrive are the first products sold/taken out of stock
Simplest method, especially for products quick to spoil
Last products to arrive are the first products sold/taken out of stock
Used to reduce net income and therefore a company’s tax bill. Controversial method used only in the U.S.
Products with the highest cost of purchase are the first products sold/taken out of stock
Used to reduce net income and therefore a company’s tax bill. Not accepted under GAAP or IFRS
Average cost / Average weighted cost
Finding the cost of products based on the average cost and does not consider purchase date
Used when it is difficult to assign a specific cost to individual items, e.g oil and gas industry
Keep in mind that each method is technically used for valuation purposes. Your inventory accounting method may not always reflect your actual inventory flow. Rather, a given method is used to assume the associated costs of a product.
The United States is the only country that allows last in, first out (LIFO) inventory accounting. LIFO is accepted under the Generally Accepted Accounting Principles (GAAP). Other countries, which use the International Financial Reporting Standards, do not.
As you can imagine, first in first out is perhaps the simplest and most acceptable method. Applying FIFO ensures your inventory is an accurate reflection of reality and limits the possibility of your books coming under scrutiny by regulators or tax authorities.
Here’s an Example of the FIFO Inventory Management Method
Let’s say your warehouse stores speakers.
- In Week 1, you order 100 speakers for $50 each.
- In Week 2, you order 400 speakers, but now they are $60 each because the supplier’s price went up.
- You now have 500 speakers in stock.
- In Week 3, you sell 400 speakers for $150 each, and you have 100 speakers left.
Using the FIFO method, you’ve sold out of the speakers that cost you $50. This means that your remaining speakers are priced at $60 each and worth $6000.
$60 x 100 = $6000 worth of speakers
On the other hand, if you used the LIFO inventory management method, those 400 speakers you sold in Week 3 would use the cost of the speaker in Week 2 ($60). As such, you would price the remaining 100 speakers at your Week 1 cost ($50), so your inventory using the LIFO method is worth $5000.
$50 x 1000 = $5000 worth of speakers
How Does a Manager Implement First in First Out Warehousing?
A warehouse manager has to ensure that FIFO happens in practice. While a corporate accountant is only concerned with the calculations, warehouse management must ensure the successful implementation of FIFO inventory control. How do you make this happen in your warehouses?
FIFO Pallet Racking System
Purchase a pallet racking system designed for FIFO warehouse management. Pallet flow rack systems, also known as gravity flow racking systems, allow your warehouse employees to feed goods into one end of a rack and retrieve it from the other end when needed. It uses the following workflow:
- Forklift feeds pallet into the rear of the pallet flow rack system
- Gravity pulls the pallet to the other end of the system
- Forklift unloads the pallet when it gets to the other end
A track or roller system along the rails of the rack tilt downwards, moving packages from the loading side to the unloading side. In this way, your oldest pallet is always the first pallet removed.
In addition to enabling FIFO inventory control, pallet flow rack systems bring the following benefits:
- Minimizes stock handling: Once workers load the pallets, they don’t handle them again until unloading. This eliminates the people and equipment (e.g. forklifts) typically required to continuously re-arrange pallets, particularly in a first in, first out warehousing space.
- Streamlines warehouse operations: All that’s needed is two free aisles on the loading side and on the unloading side. This streamlines warehouse management and makes processes more efficient.
- Maximize warehouse space: Pallet flow rack systems allow warehouse managers to pack goods more densely, effectively freeing up more warehouse space.
- Cancel construction projects: If the need for more warehouse space prompted construction plans, you may be able to scrap them using this system.
- Minimize equipment damage: Forklifts are used less frequently with pallet flow rack systems, reducing the amount of wear and tear and the frequency of repairs.
Pallet flow racks can be customized for specific speeds and product loads for the most efficiency.
Despite its benefits, pallet flow rack systems are expensive, so a business’s operations must seriously justify the investment.
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Your Existing Pallet Racking System May Not Be Suitable for FIFO
There are several ways a warehouse can organize its pallets. However, not all of these may be amenable to the FIFO method. For instance, block stacking (also known as floor stacking) is the cheapest method since it involves no racking - pallets are simply stacked on the floor. While this is easy to implement, block stacking doesn’t work in a FIFO inventory management system since pallets are pulled on a last in, first out (LIFO) basis.
Similarly, stacking frames are temporary structures erected to provide racking during busy periods. They can easily be disassembled so that the warehouse can return to block stacking.
One of the disadvantages of stacking frames and block stacking is honeycombing. Honeycombing occurs when only one load is put in the pick position in order to avoid moving packages around. It’s a trade off between handling efficiency and storage efficiency that saves on material handling but leads to warehouse space waste.
Using an Inventory Management Model to Assess Optimal Inventory Levels
Your managers double the effectiveness and efficiency of first in first out warehousing when they couple it with other best practices. Economic order quantity (EOQ) is a popular inventory management model often coupled with FIFO. This inventory control model indicates the ideal amount of stock to order once inventory dips below a certain point.
The EOQ model serves businesses by protecting them from stock outs while also minimizing the amount of capital tied up in managing excess inventory.
Employing an Automated Storage and Retrieval System (AS/RS)
An automated storage and retrieval system (AS/RS) can help with first in first out warehousing. It automatically stores and retrieves loads, minimizing the amount of manual intervention.
An AS/RS is useful in your warehouse space if you have an exceptionally high volume of loads moving in and out of storage. Depending on your company’s requirements, it may be a cheaper alternative to building more warehouse space or acquiring more property. Since machinery manages the loads, they can be packed together more densely.
An AS/RS also provides enhanced tracking and data analytics. Management can lay out the warehouse more effectively based on which items are picked most often.
Automated storage and retrieval systems can help with more than just the FIFO method and overall efficiency. It can also reduce workplace accidents and injuries.
Nevertheless, AS/RS isn't a solution to every warehouse problem. An ineffective system may lead to damaged goods if the AS/RS doesn’t handle them properly. Moreover, it may not be worth the investment if your goods require processing. It’s most effective when products simply need to be stored and transported.
What Sorts of Businesses Should Use First in First Out Warehousing?
As demonstrated, FIFO inventory control helps whether you manage goods prone to spoilage or not. This method helps business owners use warehouse space more effectively, save on labour costs, and minimize wear and tear to their equipment. FIFO is particularly useful in the food and beverage industry, apparel industry where businesses must keep up with changing trends, pharmaceutical industry, cosmetics industry, and the electronics industry where products may become obsolete. Companies that export goods also use FIFO to comply with International Financial Reporting Standards (IFRS).
FEFO: An enhanced version of the FIFO method
While most business can benefit from FIFO, some benefit more than others. In fact, it’s considered a non-negotiable in some industries.
For instance, FIFO is essential in the food and beverage business. It applies not just to warehouses, but to store owners and even a consumer’s own kitchen. Approximately one-third of food produced for humans each year is wasted. That equals about 1.3 billion tons. Not only is this a moral failure, it’s an economic failure as well. This waste represents $630 billion USD in industrialized countries.
How do you ensure food and beverages don’t go to waste in your warehouse? By implementing an enhanced version of FIFO warehouse management: FEFO. FEFO, which stands for first expired, first out, goes beyond picking the oldest pallet and focus on picking the items closest to their expiration date.
Of course, it would be incredibly difficult, not to mention expensive, to track each individual item. This is where lot control comes in. Lot control is the ability to track all the inventory in your warehouse back to its point of origin. In addition to managing spoilage, lot control allows managers to address product recalls and helps workers differentiate between similar products.
Keep in mind that expiration dates seriously impact consumer decision making. Convincing consumers to choose your products isn't as simple as getting your products to the store before the expiry date.
Only 6% of shoppers don’t check the expiration date while shopping. This isn’t surprising considering no one wants to eat spoiled food. What may be surprising to business owners is the window consumers expect between when they buy a product and when it expires.
42% of shoppers won’t buy an item if it’s too close to its expiration. What counts as too close? Well, according to the same report, anything less than 5 days is unacceptable for 25 % of shoppers.
In other words, it pays to get your products to consumers sooner rather than later.
First In, First Out Reduces Spoilage, Streamlines Processes, and Maximizes Warehouse Space
First in, first out (FIFO) warehousing is the most popular method for organizing your warehouse space. And at the accounting level, FIFO is one of the most accurate ways to calculate the amount of inventory available. The FIFO method introduces efficiency by limiting material handling and minimizing the overall usage of warehouse space.
Furthermore, it reduces the likelihood of spoilage or obsolescence, particularly for companies in the food and beverage, pharmaceutical, electronics, and apparel industries.
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Written by Ruthie Bowles
Ruthie is a content marketing consultant for Logiwa. Her specialties include small business development and inventory management.