Inventory valuation is a critical element in any effective warehouse management strategy. The right inventory valuation method speeds up picking and packing and ensures your stock is readily available and in optimal condition.
The choice of inventory accounting methods like FIFO and LIFO has significant implications for financial statements, net income, taxes, and balance sheet valuation.
Managers often hesitate between FIFO vs. LIFO, or First In First Out vs Last In First Out. These inventory methods are governed by accounting standards and are important accounting methods. Understand both strategies thoroughly so you can choose the right approach for your organization.
Table of Contents
- What Are FIFO and LIFO Inventory Methods?
- How Does FIFO Work in Warehouse Management?
- When Would You Use LIFO Instead of FIFO?
- How Does AMS Fulfillment Implement FIFO?
What Are FIFO and LIFO Inventory Methods?
FIFO (First In, First Out) means that the products that arrive in the warehouse first are also the first to be shipped out. In other words, your oldest stock will be used in the next delivery.
The purpose of FIFO is to rotate your inventory and protect your stock from spoiling or expiring. If you work with perishable goods, pharmaceuticals, or cosmetics, FIFO is an effective way to preserve inventory value and prevent products from going bad on your shelves.
LIFO, or Last In, First Out, means that the most recently acquired inventory is shipped out first. LIFO is most often used for non-perishable goods, especially when those goods are interchangeable.
The purpose of LIFO is to minimize forklift time, since goods don’t need to be moved around the warehouse as much. LIFO can also have some financial benefits, ensuring that the products you most recently paid for, which are presumably costlier due to inflation, are sold at the highest cost.
FIFO and LIFO are both inventory management and accounting techniques that are important in physical warehousing and fulfillment. FIFO and LIFO are also used to calculate the Cost of Goods Sold, or COGS, making them important financial reporting tools. It’s worth noting that, although both FIFO and LIFO have accounting applications, FIFO is the approach most often used by physical fulfillment operations.
How Does FIFO Work in Warehouse Management?
Here’s what FIFO vs LIFO looks like in practice. Both methods require careful tracking of inventory transactions, including purchases, sales, and adjustments, to ensure accurate inventory management.
The FIFO Process Explained
In the FIFO process, new stock is carefully labeled and logged, and then stored behind your older inventory. This method is designed to mirror the natural flow of goods through the warehouse, ensuring that inventory records accurately reflect the actual movement and value of stock. Here’s what the FIFO process looks like, step by step.
Step One: Receive, Date, and Log New Inventory
All new stock is immediately logged and tagged with its arrival and production date. Each inventory purchase is recorded at its actual price, which is essential for accurate cost of goods sold calculations under FIFO. Where applicable, the log should also include the expiration date.
Step Two: Organize the Warehouse
Store new inventory behind or under your older stock so that the oldest stock is most easily accessible. Many warehouses use special gravity flow racks equipped with rollers to automatically move products from the rear of the shelf to the front picking area.
Step Three: Use Visual Identifiers for Oldest Stock
Many warehouses use date-coded locations to ensure that staff pick from the oldest stock first when they fulfill orders. Dividing stock according to geography makes the storage and picking processes more efficient.
Step Four: Maintain Inventory Count
It’s a good practice to routinely audit your stock and perform thorough inventory counts. Regular inventory counts are essential for calculating inventory and maintaining an accurate inventory balance, which is critical for proper inventory valuation and financial reporting. This serves two purposes: ensuring your count is accurate and verifying that your stock is rotating correctly, so older inventory doesn’t stay on your shelves.
The result of these steps, done right, is an inventory rotation that keeps pace with the stock’s natural lifecycle, so your customers always get products in optimal condition.
Industries That Rely on FIFO
FIFO is a smart strategy for any industry that deals in perishable goods or products with an expiration date. It’s also a wise choice for industries whose products may become obsolete. Industries that manage raw materials also benefit from FIFO, as it ensures older stock is used first, reducing the risk of material degradation or obsolescence.
Some examples include:
- Food and beverage: Perishable goods, many with explicit sell-by dates, must be used while they are still fresh.
- Pharmaceuticals: Most medications and healthcare products have an expiration date.
- Cosmetics: Products will often spoil if stored beyond their expiration date.
- Fashion and home decoration: Many items will become obsolete or will cease to be in high demand over time. Seasonal items also experience demand cycles.
Benefits of FIFO for Fulfillment Operations
Many organizations choose FIFO over LIFO because of the many benefits it delivers. Here are a few of the strategy’s advantages.
Calculating FIFO Reduces Product Spoilage and Waste
FIFO drives inventory rotation, so that your oldest stock gets used before it goes bad. The result minimizes waste and helps make sure that your warehouse is stocked with fresh products.
Minimizes the Risk of Selling Expired Products
Selling expired products can lead to full or partial recalls and frustrated customers. Depending on your industry, it may also lead to penalties. FIFO mitigates the risk of having expired products on hand by ensuring your inventory rotates regularly.
Improves Product Quality
FIFO keeps your inventory fresh, so that your customers receive high-quality products in the best possible condition.
Drives Higher Inventory Accuracy
Regular, systematic inventory rotation makes it easier to track and trace inventory for greater accuracy.
Aligns With Consumer Expectations
Many industries are closely regulated to ensure that they deliver fresh, healthy products. FIFO makes it easier to stay compliant with those regulations, ensuring that stock gets shipped out before it reaches its expiration date. By the same token, FIFO helps organizations meet customer expectations for fresh, healthy products.
When Would You Use LIFO Instead of FIFO?
Some warehouse managers still hesitate between FIFO vs LIFO. FIFO is much more widely used, but there are still some situations where LIFO is a good choice.
Here are some of the key considerations to keep in mind when choosing between the two strategies.
Limited Physical Applications of LIFO
LIFO can be a good strategy for organizations that deal with bulk materials where items are indistinguishable. Construction materials, like bricks or cement, fall into this category.
More generally, any non-perishable goods stored in deep lanes or stacks may be good candidates for LIFO, as well as many industrial components. LIFO can often work when product degradation isn’t a concern, or when there is no risk of the product becoming obsolete. However, using LIFO can result in leftover inventory, as older stock may remain unsold for longer periods, which can impact inventory valuation and management.
If newer stock is already more accessible than older stock, then LIFO may be a good choice too. The process reduces labor hours and costs, and can speed up fulfillment by limiting the time spent on warehouse organization.
Why LIFO Is Uncommon in Modern Fulfillment
Today, LIFO is a little-used strategy because organizations want to avoid getting stuck with inventory they can’t move. LIFO often results in lower inventory value on the balance sheet during inflation, which can be a disadvantage for companies.
For most organizations, product obsolescence is a real concern. Even when there’s no risk of items expiring or spoiling, they may simply go out of style or be surpassed by a new product.
LIFO increases the risk of dead stock accumulation, with older, potentially obsolete items piling up in warehouses. LIFO also creates potential for quality control issues and dissatisfied customers. When older inventory is left in the warehouse, its quality may deteriorate, leading to regulatory challenges or frustrated customers.
Briefly, in most cases, FIFO is a better choice than LIFO. The challenge with either is to implement it effectively. That’s where the right 3PL logistics partner, like AMS Fulfillment, makes a big difference.
How Does AMS Fulfillment Implement FIFO?
AMS Fulfillment uses a combination of proprietary technology, warehouse management strategies, and rigorous quality control measures to implement FIFO. Here’s what that looks like.
Implementing FIFO With Digital Tools
At AMS, we use our own proprietary software to optimize warehouse and inventory management. Our system, WAMS, has been carefully programmed and supported by AMS’s in-house IT Team over many years to deliver the warehouse management and inventory management tools our customers rely on.
Our staff uses barcodes and scanning to validate receipt of goods and record their arrival dates, facilitating inventory tracking and rotation. The combination of software and scanning allows AMS to track inventory by lot numbers, expiration dates, and receiving dates, so that no item gets forgotten or left in the back of the warehouse to spoil.
Implementing Warehouse Organization Strategies
At AMS, we implement and maintain time-tested warehouse management strategies like batch management and zone picking, so that the picking process is as efficient as possible. Our system streamlines warehouse layout so that inventory rotation becomes intuitive and consistent. We also provide ongoing training for warehouse staff on FIFO compliance.
Our teams perform quality checks at every stage to ensure that products are in good condition on arrival and are fit for customer use when they ship out for delivery. Regular audits and cycle counting ensure that inventory levels are accurate and that stock is being regularly rotated.
Delivering Inventory Visibility
Complete, real-time inventory visibility means AMS clients always know exactly where their stock is located and how much inventory they have available. Even if some of that inventory is in motion, they can track it.
The AMS Client Portal offers unbeatable access to inventory data, from order tracking to stock levels. It’s easy to customize and offers intuitive controls and streamlined processes, speeding up decision-making. Our technology also integrates with other platforms, like ERP and BI, for greater insight into your whole operation.
Example of How FIFO Prevents Waste and Returns
Let’s imagine that a business sells organic protein bars, made with natural, highly perishable ingredients.
The protein bars expire after six months. Unless inventory is consistently rotated, older bars could be stored behind the new stock and forgotten. That could easily result in the old stock being left to expire in the back of a warehouse. If the expired protein bars are shipped out, they will disappoint customers and could damage the company’s reputation.
The right tools and protocols will prevent this from happening. At AMS Fulfillment, we assign a unique barcode to every product that comes into the warehouse, and that barcode includes data about the product’s expiration date. We also use warehouse zones to ensure that older items are placed in front of newer arrivals.
When an order comes in, our warehouse management software directs staff to the racks holding the oldest stock so that it gets used before its expiration date. As a result, the older protein bars get shipped out in time for customers to enjoy them at their freshest and most wholesome.
FIFO vs. LIFO: Choosing the Solution that Meets Your Needs
Both FIFO and LIFO have advantages, but for most modern businesses, FIFO delivers much greater benefits to your customers and your business.
FIFO is the right choice for any business whose products can spoil, expire, or become obsolete. Today, due to the fluctuating nature of consumer demand, most products can easily become outdated. This makes FIFO a smart choice, since it protects you from dead stock piling up in warehouses.
Implementing FIFO solutions is easy when you have the right partnerships in place. Contact us today to learn how AMS fulfillment can help you with every stage of fulfillment, from warehousing to delivery.
Frequently Asked Questions
Is FIFO or LIFO better for e-commerce businesses?
FIFO is almost always better for eCommerce businesses. It ensures customers receive the freshest products while making sure items don’t sit in the warehouse past their expiration date. FIFO also reduces returns due to expired or degraded items.
Even if you’re selling non-perishable items, like clothing or home decorations, FIFO is a smart choice. The strategy allows you to get inventory out to customers while it is at its most fashionable and in demand, instead of waiting while it goes out of style. Most eCommerce fulfillment operations use FIFO exclusively.
Can you use both FIFO and LIFO methods in the same warehouse?
While it is possible to use both FIFO and LIFO in the same warehouse, it’s not recommended for physical inventory. You might use FIFO for physical fulfillment while using LIFO for accounting purposes, but mixing methods for actual product movement creates confusion and increases error risk. Inventory management strategies work best when they are streamlined, consistent, and intuitive.
How does a 3PL like AMS Fulfillment track FIFO compliance?
Professional 3PLs use warehouse management systems (WMS) that automatically track lot numbers, expiration dates, and receiving dates. They also perform regular cycle counts to ensure that inventory levels are accurately recorded. Scannable barcodes enable 3PLs to track shipments, pallets, and even individual items at the most granular level.
The best professional 3PLs use a combination of technology, strategy, and careful planning to track FIFO compliance and protect clients from regulatory penalties.
