Periodic FIFO, or first-in-first-out, is a common inventory management method used by businesses to ensure that their products are sold or used in the order in which they were purchased. This method involves periodically evaluating the cost and quantity of inventory on hand and assigning a cost to products sold based on the cost of the oldest inventory.
Calculating periodic FIFO can be a bit complex, especially if your business deals with a large number of products and frequent inventory turnover. However, it is crucial to master this method if you want to optimize your supply chain and maximize your profit margins. In this article, we will delve into the basics of periodic FIFO and explain how you can calculate it for your business. By the end of this article, you should have a solid understanding of this inventory management method and be able to apply it to your own business operations.
Understanding the Basics of FIFO Method
The FIFO (First-in-First-out) method is a widely used inventory management system. It works on the principle of the stock that is first received, is also the first one to be sold. The FIFO system assumes that the cost value of the most recent inventory is higher than the value of the inventory that was purchased earlier.
The method is based on a relatively simple idea, but it can be a bit tricky to implement if the business deals with a large inventory. The FIFO method takes into account the cost of the oldest inventory on hand when calculating the value of goods sold. This is important because it helps businesses to maintain an optimal level of stock while also ensuring that they do not accidentally sell products that have expired or are no longer in demand. To fully understand FIFO method and its calculation, it is necessary to understand the basics of inventory management first.
Step-by-Step Guide to Periodic FIFO Calculation
Periodic FIFO calculation refers to the method of valuing inventory based on the assumption that the first items purchased are the first sold. This method assumes that the cost of the items sold is the cost of the items purchased first. To calculate periodic FIFO accurately, you must follow a step-by-step process.
Firstly, you need to obtain the cost of goods available for sale during the accounting period. Next, you need to identify the cost of goods sold during the accounting period. This can be done by subtracting the ending inventory from the cost of goods available for sale. Then, you need to determine the cost of goods remaining in inventory by subtracting the cost of goods sold from the cost of goods available for sale. Finally, you need to divide the cost of goods remaining in inventory by the number of units remaining in inventory to find the unit cost. Following these steps will help you to calculate periodic FIFO accurately and efficiently.
The Significance of FIFO for Inventory Management
FIFO (First In, First Out) is a widely used inventory management method that ensures that the oldest stock items are sold or used first, leaving newer items for later. This approach is significant for inventory management because it helps in reducing the risks of keeping large amounts of stock that become outdated, perishable, or stale. By following the FIFO method, businesses can improve their inventory turnover and increase their sales, which is essential for a profitable business.
Another significant benefit of FIFO in inventory management is that it helps businesses maintain their stock’s quality and reduces the risk of product obsolescence. It ensures that the stock is sold out sooner, preventing it from getting expired or obsolete, reducing the possibility of writing off worthless inventory. FIFO also helps businesses in reducing the holding costs associated with stock management, such as storage space costs, transportation fees, and handling charges. Implementing the FIFO method not only ensures a smooth inventory process but also increases the operational efficiency and profitability of a business.
FIFO vs LIFO: Which is the Better Inventory Accounting Method?
FIFO and LIFO are the two most common inventory accounting methods used by businesses. FIFO stands for First In, First Out, while LIFO stands for Last In, First Out. The main difference between these two methods lies in the way they calculate the cost of goods sold (COGS).
FIFO assumes that the first item purchased is the first one sold, while LIFO assumes that the last item purchased is the first one sold. FIFO is generally considered to be the better inventory accounting method for businesses that sell perishable goods or goods that have a short shelf life. This is because FIFO ensures that older inventory is sold first, reducing the risk of spoilage or obsolescence. On the other hand, LIFO tends to be more favorable for businesses that sell items with a higher purchase cost, as it allows them to reduce their tax liability by reporting a lower taxable income. Ultimately, the choice between FIFO and LIFO depends on the nature of a business and its inventory management needs.
Common Mistakes in Periodic FIFO Calculation and How to Avoid Them
When calculating periodic FIFO, there are several common mistakes that can occur, leading to inaccurate results. One of the biggest mistakes is failing to properly identify and match costs with the correct inventory batches. This can result in incorrect cost of goods sold calculations and distorted profit margins. To avoid this mistake, it is crucial to maintain accurate records of inventory batches and their associated costs.
Another common mistake is failing to account for inventory changes, such as returns, damaged goods, or shortages. These adjustments can have a significant impact on FIFO calculations, particularly if they occur after a sale has been made. To avoid this mistake, it is important to regularly reconcile inventory records and adjust calculations accordingly. Additionally, it is crucial to ensure that all relevant parties, such as sales and accounting teams, are aware of any changes to inventory levels or costs in order to prevent errors or discrepancies.
Tracking Inventory Costs with Periodic FIFO
To track inventory costs using Periodic FIFO (First-In-First-Out), you first need to calculate the cost of goods sold by adding up the cost of each sale. Then, you need to figure out the cost of the inventory that remains at the end of the period by adding up the cost of the remaining units.
The final step is to calculate the total cost of goods available for sale by adding the beginning inventory to the total purchases made during the period. Once you have this value, you can divide the total cost of goods sold by this figure to calculate the cost of goods sold percentage. This percentage can then be multiplied by the total cost of goods available for sale to determine the cost of ending inventory. This process ensures that you can accurately track inventory costs and make adjustments as needed.
Best Practices for Implementing Periodic FIFO in Your Business
Implementing periodic FIFO (First In First Out) in your business can be challenging, but it is necessary to maximize profits and minimize costs. By using this method, you can ensure that inventory is sold or used according to the order it was received, which can reduce spoilage, waste and dead stock. However, to successfully implement periodic FIFO, businesses need to follow several best practices.
Firstly, it is crucial to have an organized inventory management system. This includes labelling and tracking inventory, monitoring expiry dates, and regularly auditing stock levels. This will ensure that the oldest stock is always sold or used first and provide accurate data for future forecasting. Secondly, it’s important to train employees on the FIFO system and ensure they understand the importance of following the procedure. Management should also regularly review and enforce the system to ensure continued compliance. By adhering to these best practices, businesses can effectively implement periodic FIFO and gain a significant competitive advantage.
Conclusion
In conclusion, calculating the periodic FIFO method involves keeping track of the cost of goods sold for each period and adjusting the inventory balance accordingly. This method helps businesses accurately track inventory costs and ensure they are utilizing the oldest inventory first, reducing the risk of obsolescence or spoilage. By following this method, businesses can make more informed financial decisions and better manage their inventory.
Overall, periodic FIFO is a crucial accounting method for businesses that deal with perishable or time-sensitive inventory. By implementing this method, businesses can ensure efficient inventory management and reduce waste and losses. While it may require some extra effort to implement, the benefits of using periodic FIFO can ultimately contribute to the success and profitability of a business in the long run.
