What is the FIFO system

The FIFO (First In, First Out) system is an inventory management and asset valuation method based on a simple chronological rule: the first goods placed in stock are the first ones sold, used, or disposed of.

Businesses utilize this framework to manage the physical flow of products and calculate the financial value of their remaining inventory.

📦 How the Physical FIFO System Works

In operations and logistics, the FIFO system requires a business to structure its warehousing and shelf space so that older stock is always accessible ahead of newer stock.

• The Setup: When new items arrive, they are placed at the back of the queue. Existing items are pushed to the front to be selected by pickers or customers.
• Perishable Management: This system is critical for handling goods with expiration dates. It prevents items from spoiling, degrading, or becoming obsolete while sitting forgotten at the back of a shelf.
• Primary Examples: Supermarkets constantly restock milk and fresh produce from the back so consumers grab the older inventory first. Similarly, pharmaceutical companies rely heavily on FIFO to ensure life-saving medicines are distributed well before their expiration deadlines.

📊 The Accounting Side: Costing and Profits

Beyond physical boxes, FIFO is a heavily regulated accounting method approved by both IFRS (International Financial Reporting Standards) and US GAAP. It dictates how a company calculates its Cost of Goods Sold (COGS) and the value of its ending inventory.

Under financial FIFO, when a product is sold, the cost attributed to that sale is matched to the price paid for the oldest available unit in the ledger.

📈 The Impact of Inflation

Because prices generally rise over time, FIFO has a specific impact on a company’s financial health during inflationary periods:

1. Lower Expenses: The company records its oldest, cheapest purchase costs as COGS on the income statement.
2. Higher Profits: Because the recorded costs are low, the company reports a higher net income and greater profitability on paper.
3. Higher Taxes: A higher reported profit means the business will face a larger corporate income tax liability.
4. Current Balance Sheet: The remaining balance sheet inventory is highly accurate because it is valued at recent, higher market prices.

💡 Core Advantages & Disadvantages

• Pros: Highly intuitive, matches the actual physical flow of most businesses, minimizes waste from expiration, and leaves ending inventory values closely aligned with current market prices.
• Cons: Can artificially inflate corporate tax bills during periods of high inflation. It can also distort financial health by mismatching older, historical costs against current, inflated revenues.