Inventory management is an essential operational concept for organizations that operate based on a product-oriented approach. First in First Out is a standard product management system that is designed to ensure that investors monitor and make effective stock choices. While cash flow and financial management is an essential aspect for determining a company’s ability to achieve its set objectives, stock management determines the rate of stock movement. Industries operating under FIFO assume that first goods purchased for resale should be the first products to be sold from the store (Collis, Holt, & Hussey, 2017). This assumption may fail in some situations because some companies store old and new stock within the organization. Generally, economic fluctuations and risks associated with the production of goods enhance the profitability of organizations using FIFO. Thus, the FIFO stock management method has a positive impact on manufacturing industries.
FIFO Stock Rotation and Its Importance
Stock rotation is a simplified product management system that is applied by small and large retail companies. FIFO stock rotation entails the presentation of older products for sale in a manner that is likely to attract customers. The older goods are displayed in a way that makes them look unique compared to the newly introduced ones. The primary objective of this method is to push the older items out of the door to give room for the newer commodities (Bertolini et al., 2013). Though FIFO is applicable in almost every store, it is evident that the process is extremely valuable in stores that sell perishable goods. For instance, as the expiry date for selling such products approaches, stockers push the commodities in open spaces where customers have increased access to them, to improve the purchase rate for the perishable commodities. In effect, the approach mitigates the possibility of incurring losses associated with the expiration of goods. Additionally, most commercially packed products have predetermined expiry dates, and in cases where stockers fail to sort the goods such that buyers access the commodities that are likely to expire first, there is a possibility that the business will operate at a loss. FIFO enhances the efficiency of stock rotation and in turn, increases organizational profitability.
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Stock rotation is essential in every production phase, including the factory, warehouse, and retail display stages because it increases the chances of lowering the total losses that may result from obsolescence and deterioration. Whenever a company carries out a stock rotation, the units need to be sorted following the First In, First Out criteria. However, accountants are required to track the cost of inventory and sales, a factor that facilitates the application of the cost flow assumption. Manufacturers consider stock rotation to be essential in helping a business maintain a positive public image. Organizations using the named approach usually have employees that are assigned the specific task of assessing whether it is time to take out the older products from the display across all company outlets. In doing so, the chances of customers purchasing products that have almost expired reduce. Therefore, FIFO assists companies in avoiding losses that may result from the display of commodities that have nearly expired (Collis, Holt, & Hussey, 2017). Organizations that use stock rotation often have the opportunity to shift products to the forefront of display shelves and sell them at discounts. Discounted sales increase the chances of mitigating business losses that would otherwise result from the expiration of commodities.
Effects of FIFO Affect Inventory Quality
The proper management of inventory is essential in ensuring organizational sustainability within the industry a business operates. FIFO expenses the oldest stock first living the newly produced commodities in the market. The Cost of Goods Sold depends on the inventory valuation method applied by a business. Therefore, FIFO creates an opportunity for positively impacting the financials of an organization, primarily considering that inventory valuation depends on the worthiness of the balance sheet, which provides information regarding the viability of the company’s investment (Spiceland, Nelson, & Thomas, 2018). Organizations that use the FIFO inventory method are better placed to increase their inventory logs, especially with their current assets, due to the realization of a higher current ratio. Thus, FIFO enables organizations to offer relevant services, which increase the opportunity for expanding a corporation’s ability to depict its viability through its existing assets.
A company that purchases or manufactures goods for resale should be capable of determining the number of products available for resale. The inventory method that a business applies affects the cost of goods sold. In turn, the cost of goods sold also impacts the profitability ratios for a business. Hence, the value of products sold is achieved by taking the total cost of goods sold and adding them to the number of inventory goods, then subtracting the cost of ending an inventory. As a result, a company that uses FIFO in valuing its stock is always in a position to record lower COGs (Simeon & John, 2018). Therefore, FIFO enables corporations to increase their profit margins and net incomes. In cases where a company records a higher net income, it follows that the business can file a higher profit margin. In effect, retail stores using FIFO record high-profit levels compared to companies applying any other type of inventory method.
Effects of FIFO on inventory Costs
FIFO is used for cost flow assumptions and creates an opportunity for ensuring that a company monitors its products through different manufacturing stages. The costs associated with the production of commodities are perceived as expenses and should be considered in the FIFO manufacturing and production approach (Simeon & John, 2018). As a result, FIFO ensures that products are assigned costs as they are being prepared for sale. FIFO factors in the prices of products by ascertaining that the production costs are taken into account. The allocated commodity expenses apply in the order in which products arrive in the store and are sold. Thus, the determination of commodity prices is based on the capability of products to serve organizational interests. A company applying FIFO to govern its operations uses the first product arrival rule to determine the distribution patterns of commodities, a factor that enhances a corporation’s ability to serve its interests.
In most cases, organizations that choose to forfeit the application of the principles provided by FIFO predispose themselves to experience inventory costs that often translate to losses. For instance, the lack of sale of organizational products may lead to the realization of diminished profits. FIFO mitigates such occurrences by ensuring that commodities that are stocked later remain at the back of the shelves, making them less attractive to consumers. Thus, the application of FIFO puts businesses is in a position that reduces the costs of inventory which would result from selling commodities at prices that are lower than the purchase rate or failing to present the products to the market. Without FIFO inventory management strategies, organizations increase the risk of recording losses associated with current liabilities exceeding current assets (Collis, Holt, & Hussey, 2017). This process makes it difficult to match what is currently available for sale with the price of the commodities. The mismatch between sale rates and current products in the market reduces the ability of an organization to ensure that it maximizes the benefits of its inventory.
Implementing FIFO in a Warehouse
Various strategies need to be applied in implementing FIFO in warehousing. In most cases, this approach needs to be used irrespective of whether the products are subject to perishability. The First In, First Out principle helps a company in managing its overall operations, thus increasing the viability of the business in realizing its objectives (Bertolini et al., 2013). The warehouse management system should enhance an organization’s inventory evaluation process. For example, if the commodities are organized based on their expiry dates, the warehouse management team can apply the same strategy in creating a warehousing system that allows the shipping of older products first to avoid any product supply issues. FIFO operates by ensuring that products whose expiry date is closer are sold first to prevent losses that would result from commodity spoilage. Thus, the application of FIFO in warehousing requires the arrangement of items in a manner that increases the accessibility of older commodities compared to the newly produced ones.
FIFO also requires a warehouse management system which ensures that stack pelleting is aligned appropriately to avoid issues associated with the selection of newer products over older ones. Therefore, the stack palettes for new products must not be mixed with those of older commodities, and the old pallets should be preferably placed on top of the new ones to increase their accessibility to buyers. Moreover, a clear labeling system must be used to attract the attention of buyers to the older products, easing the selection process thereof and ensuring that the commodities that are stocked less recently leave the warehouse first (Atieh et al., 2016). Hence, a warehouse commodity roll out system should ensure that products are arranged in a manner that encourages buyer acquisition of the older stock as opposed to the newer one.
Alternatively, sequential pallet licensing can be applied in a situation where the dated expiry list is not available. In circumstances where palletized materials arrive at the store, warehouse operators may be in a position to ensure that they use an ascending licensed plate approach to serve organizational interests in ensuring that the old stock leaves the warehouse first. This strategy ensures that old pallets have lower pallet IDs, making FIFO an applicable mechanism for sorting inventory in the warehouse (Atieh et al., 2016). Warehouse operators can also implement the operation approach by using FIFO to control group pallets received on a particular day. In such a case, the preprinted lot tags may be used to ensure that products remain in the market and increase the ability to facilitate the input of both date and time specifications when listing commodities on the inventory. In turn, warehouse operators can categorize the products depending on the period for which the products have been in storage.
Advantages of FIFO in Accounting
FIFO inventory management approach ensures that a company factors in the status of its current accounts. As a result, organizations that use FIFO exploit advantages that they would have otherwise not experienced if they applied other inventory approaches. For instance, the FIFO method allows the conservation of monetary and time resources with regard to the calculation of the costs and expenses associated with a particular inventory (Griffin & Wright, 2015). FIFO eases the process because the prices applied for commodities depend on the cash flow realized from product purchase within organizational stores. The named approach encompasses the assessment of the specialties that need to be used in ensuring that commodities are received in the market. Hence, the ease of understanding the concepts that FIFO promulgates makes it an advantageous accounting tool.
The identification of product costs in an inventory may be problematic. In such cases, FIFO is a reasonably practical approach because it defines the prices of products before they reach the point of sale. Companies that apply other inventory approaches experience challenges in determining the prices of products at the end of the purchase, a problem that FIFO is designed to rectify. Thus, through the application of the FIFO principles, businesses can effectively compare the costs and prices of commodities, a factor that allows the consistent valuation and accounting of products, thereby mitigating losses.
FIFO provides critical information in the financial accounting processes. Inventory mechanisms apply the named strategy by increasing the difficulty of manipulating the data that is presented in income statements. FIFO discourages the vagueness of the values used in recording costs, sales, profits, and losses within an organization. Moreover, it creates an opportunity to increase gross and net earnings in instances that issues of inflation may be at play (Simeon & John, 2018). Under FIFO, the cost of sales equals the sum of opening stock and purchases less the closing stock, a factor that increases the ability of a business to track the flow of goods from its stores.
Disadvantages of FIFO in Accounting
Companies that use the FIFO inventory method also experience demerits of application of the technique, including those associated with higher tax liabilities, which reduce the possibility of business success within an industry as a result of heightened cash outflows and charges. Therefore, the application of FIFO principles in cases where hyperinflation is involved becomes unsuitable because of the lack of specific price and inflation patterns (Simeon & John, 2018). Hence, comparing purchases and sales prices becomes challenging, resulting in the inapplicability of FIFO. When there is inflation or hyperinflation in the market, the distorted patterns of revenue acquisitions may not create a clear picture of the state business operations.
FIFO also becomes an inappropriate method of managing inventory in situations where products experience price fluctuations because it may result in the miscalculation of profits for products that are acquired within different periods. The prices of commodities may be higher in a particular period and low during a different interval, making it difficult to determine the reliability of the profit margins that are realized. Thus, the FIFO pricing approach may be easy to explain but is associated with difficulty in the calculation and extraction of the exact cost of in-store products (Spiceland, Nelson, & Thomas, 2018). The process requires a substantial amount of data, thus subjecting the formula to clerical errors. There is no significant difference between FIFO pricing technique and any other pricing strategy because of the dependency of the same on inflation. In effect, the process oversimplifies the calculation of the costs that may absorb the impact of the variables in-stock inventory.
Conclusion
FIFO stock rotation is a critical process in ensuring that companies have a successful stock monitoring approach. FIFO stock rotation reduces organizational costs and losses for both the producers and the vendors. The implementation of FIFO in warehousing requires the operators to consider expiry dates and implement strategies that minimize the possibility of selling new over old stock. However, the stock inventory approach is not applicable in all cases. For instance, the information provided under FIFO may be unreliable in situations of hyperinflation. In some cases, the process may be costly as older products may require companies to offer significant discounts. Regardless, the advantages for FIFO outweigh its disadvantages, making it easy for companies to avoid losses by applying the named strategy.
References
Atieh, A. M., Kaylani, H., Al-abdallat, Y., Qaderi, A., Ghoul, L., Jaradat, L., & Hdairis, I. (2016). Performance improvement of inventory management system processes by an automated warehouse management system. Procedia Cirp, 41, 568-572.
Bertolini, M., Bottani, E., Rizzi, A., Volpi, A., & Renzi, P. (2013). Shrinkage reduction in perishable food supply chain by means of an RFID-based FIFO management policy. International Journal of RF Technologies, 5(3-4), 123-136.
Collis, J., Holt, A., & Hussey, R. (2017). Business accounting. Palgrave.
Griffin, P. A., & Wright, A. M. (2015). Commentaries on Big Data's importance for accounting and auditing. Accounting Horizons, 29(2), 377-379.
Simeon, E. D., & John, O. (2018). Implication of Choice of Inventory Valuation Methods on Profit, Tax, and Closing Inventory.
Spiceland, J. D., Nelson, M., & Thomas, W. (2018). Intermediate accounting. Ninth edition.: McGraw-Hill Education
