What Is the FIFO Method? Definition, Pros, and Cons

If you’re running a store or a warehouse, you wouldn’t want the products that have been sitting there the longest to be forgotten in the back, right? That’s exactly what the first in, first out (FIFO) method prevents. FIFO requires the oldest products to go out first, keeping your inventory fresh, reducing waste, and avoiding spoilage and outdated stock. It’s a game-changer for businesses that handle perishable or time-sensitive goods, helping maintain quality, accuracy in orders, and happy customers. It also helps operations run smoothly and supports steady cash flow, making it an important strategy for both stores and 3PL providers like Encore Fulfillment.

What Is FIFO in Inventory Management?

FIFO in inventory management refers to the oldest products being sold or shipped before newer ones. This simple yet effective approach helps prevent items from expiring or becoming outdated, which is essential for products like food, cosmetics, and pharmaceuticals. Compared to last in, first out (LIFO), which uses newer stock first, FIFO keeps products moving in the order they arrive, reducing waste and keeping customers satisfied.

For example, if a warehouse receives cosmetic products in January and then more in February, FIFO makes sure the January batch is sent out first. This keeps products fresh, protects them from spoiling, and helps operations run smoothly.

How Does FIFO Work in 3PL?

In a third-party logistics 3PL warehouse, FIFO makes sure products are picked, packed, and shipped in the order they arrive. This keeps inventory up to date and fresh, preventing outdated items from being sent out. When shipments come in, they are labeled and stored by the arrival date, and systems like barcode scanners, RFID tags, and inventory software guide staff to use the oldest stock first.

FIFO involves storage and helps with picking, packing, shipping, and fulfilling orders. For example, a system may direct workers to take items from bins or pallets with the oldest stock. Using innovative technology and organized layouts, 3PL providers like Encore Fulfillment can deliver accurate and high-quality shipments on time.

FIFO Formula and Calculation

You can use FIFO to calculate how much it costs to make the items you sell, cost of goods sold (COGS), and your gross profit. First, multiply the cost of your oldest inventory by the number of units sold.

For example, let's say you own a store that sells handmade soaps, and these are your last two inventory orders.

If you sell 110 soaps at $20 each, your total revenue is $2,200.

Using FIFO to determine the COGS yields:

• First 100 units come from batch 1: 100 × $5 = $500
• Next 10 units come from batch 2: 10 × $7 = $70

Total COGS = $500 + $70 = $570

Then, calculate the gross profit:

Gross profit = Revenue - COGS = $2,200 - $570 = $1,630

Using FIFO allows you to track the real cost of the goods sold, maintain accurate financial records, and see exactly how much profit you earn from selling your inventory.

Pros and Cons of FIFO

FIFO is a common way to keep inventory organized and products fresh. But it doesn’t work for every business. Here are the main pros and cons to help you decide if FIFO is right for you.

Pros

• Reduces waste by using older items first
• Keeps products fresh and high quality
• Makes inventory easier to track and to manage
• Matches the natural flow of most stock
• Helps meet safety and expiration rules
• Keeps customers happy with fresh products
• Can lead to higher profits during inflation

Cons

• May increase taxes in inflationary times
• Not ideal for non-perishable or slow-selling items
• Needs organized storage and good tracking
• Can take more work without automation
• Might not be cost efficient if prices change quickly
• May not fit some specialized industries

Industries Where FIFO Makes the Most Sense

FIFO works best in industries where freshness, quality, and safety matter most. In the food and beverage industry, FIFO helps sell older products first to prevent spoilage. Pharmaceutical companies use it to follow strict rules and to ensure that medications are effective. Cosmetic and personal care brands rely on FIFO to keep products fresh and to avoid expired items.

In e-commerce, especially for seasonal and trending products, FIFO moves older stock before newer items. Manufacturers also use it to process raw materials in the right order, making sure that quality is consistent. For businesses where product lifespan or safety matters, FIFO is a smart and often necessary choice.

Why FIFO May Not Work for Every Business

FIFO is popular, but it doesn’t work for every business. Companies selling non-perishable goods, like construction materials, or high-value items like jewelry, may not need to or want to sell older stock first.

FIFO can also affect taxes during inflation. Older inventory may be cheaper, and it is recorded as sold first, which can increase profits and therefore taxable income. For businesses dealing with fast-changing costs or trends, selling newer products first might be more profitable. In these cases, FIFO may not be the best choice.

FIFO vs. LIFO

FIFO and LIFO are two popular ways to manage inventory, each with its own strengths. Let’s break down the key differences so you can see which method fits your business best.

• Order of inventory: FIFO sells the oldest stock first, and LIFO sells the newest stock first.
• Best for: FIFO is great for perishable and regulated items to keep them fresh; LIFO works better for non-perishable goods and commodities.
• Financial effects: FIFO can help earn higher profits during inflation; LIFO can lower taxable income.
• Inventory flow: FIFO follows the natural product flow, making tracking easier; LIFO may not match actual stock movement.
• Compliance: FIFO is easier for regulated industries; LIFO may be restricted in some countries.

Should You Use FIFO?

If you sell perishable, regulated, or quick-to-expire items, FIFO is usually the best choice. It keeps stock fresh, adheres to regulations, and maintains customer trust. For non-perishables in an inflationary market, LIFO may help reduce taxes. Choose the method that best suits your products, industry, and long-term goals. However, for many retail, e-commerce, and logistics businesses, FIFO offers a good balance of quality and cost control.

Summary

Quick recap: FIFO is an easy and effective way to keep products fresh, to cut waste, and to manage your inventory system and accounting records, making it essential for industries like food, pharmaceuticals, and e-commerce. While it’s not an ideal option for every business, especially those with non-perishables or specific tax strategies, it works seamlessly with modern warehouse systems and logistics operations.

At Encore Fulfillment, we combine FIFO with other smart inventory strategies to keep your operations running smoothly, compliantly, and cost effectively. Your products always move in the right order, and they’re delivered fresh, fast, and ready for your customers.