Maximising Profit: How FIFO Method Can Help Minimise Cost of Goods Sold

Are you looking for ways to maximise your profits and minimise costs? One method that can help with this is the FIFO (First-In-First-Out) Method. This effective inventory management technique ensures that goods are sold in the order they were purchased, which can result in lower costs of goods sold and higher profit margins. In this blog post, we will dive into what exactly the FIFO Method is, how it works, as well as its advantages and disadvantages. So grab a coffee and let’s explore how procurement and cost of goods sold using FIFO can benefit your business!

What is the FIFO Method?

The FIFO Method is an inventory management technique used by companies to calculate the cost of goods sold (COGS) and manage their inventory. The method assumes that the first items purchased are also the first ones sold, hence its name.

Essentially, this means that older or obsolete stock is removed from shelves before newer stock, reducing waste and increasing efficiency. This can be particularly useful for businesses with perishable products or items with a short shelf life.

In practice, this involves keeping a detailed record of when goods were received into inventory and at what cost. When selling these goods later on, the oldest item in stock should be attributed to each sale until there’s none left in the warehouse.

While it might seem like a simple concept, implementing it effectively can have significant benefits for your business’s bottom line. Let’s explore how exactly it works next!

How does the FIFO Method work?

The FIFO (First In, First Out) method is a popular inventory management technique that helps businesses manage their stock and cost of goods sold. This method assumes that the first items to be purchased or manufactured are also the first to be sold or used.

To understand how this works, let’s assume that you run a retail store selling shoes. You place an order for 100 pairs of shoes at $50 each on January 1st. On February 1st, you receive another shipment of 200 pairs at $60 each. On March 1st, you get another delivery of 150 pairs at $70 each.

When it comes time to sell these shoes in your store, using the FIFO Method means that you will sell the oldest pair from your January shipment before moving onto February and then March shipments in chronological order.

By following this approach, you can ensure that your older inventory doesn’t go unsold while newer products take up valuable shelf space. Additionally, since the older inventory was likely purchased at a lower price point than newer inventory (due to inflation and other factors), using FIFO can help minimise your Cost Of Goods Sold (COGS).

Advantages and disadvantages of the FIFO Method

The FIFO method is one of the popular inventory management techniques used by businesses. It comes with a few advantages and disadvantages that are worth considering.

Advantages:
One significant advantage of using the FIFO method is that it provides a better representation of cost flow, especially when dealing with perishable goods or products whose prices frequently change. Additionally, this method ensures that older items get sold first before newer ones, reducing waste and spoilage.

Another advantage is its simplicity in application. The first item to be added to inventory is also the first item to leave; hence there’s no confusion about which product gets sold first.

Disadvantages:
On the downside, implementing FIFO can lead to higher taxes as it results in lower net income due to higher costs associated with older inventory being sold at current market prices.

Moreover, managing an efficient FIFO system can be time-consuming and challenging for companies with large inventories or complex supply chains. Overstocking could result in increased holding costs for unused items while understocking might interrupt production processes if raw materials run out unexpectedly.

While there are benefits for businesses who use the FIFO method such as better cost flow representation and reduced waste/spoilage risks; there are also drawbacks like potential tax increases and time-consuming implementation processes.

Conclusion

The FIFO method is a valuable tool for businesses looking to reduce their cost of goods sold and maximize their profits. By ensuring that the oldest inventory is sold first, it helps companies avoid obsolescence and wastage while maintaining accurate records.

However, it’s important to note that the FIFO method may not be suitable for every business or situation. Companies with perishable or rapidly changing products may benefit more from other inventory management methods.

Understanding how to use the FIFO method effectively can help businesses save money on taxes and increase profitability in the long run. With careful planning and implementation, this simple yet effective strategy can make a significant impact on your bottom line.