FIFO Method Formula Definition
First In First Out (FIFO) is a method of asset management and valuation methods in which assets which are acquired first are sold first. Under FIFO, the cost of your oldest inventory is used in calculating COGS.
Significance of FIFO Formula
The FIFO inventory method formula is considered one of the most trusted methods as it focuses on selling old items first. It offers benefits such as:
- Following a natural inventory flow: FIFO formula tends to keep the oldest stocks being cleared first and the accounting goes by the costs first. This makes bookkeeping more manageable and concise, with negligible mistakes.
- Least waste: The FIFO inventory method formula follows the least waste, using the oldest inventory first.
- Provides a better reflection of a market value: The remaining products in the inventory better reflect a market value. This is because the products have yet to be sold and have been built recently.
- Higher profits: Since the FIFO inventory method formula follows the first come first serve method, it ensures higher profits.
Applications of FIFO Method Formula
FIFO method is affordable and helps to maintain a concise asset management procedure. The FIFO method formula holds the following application in an e-commerce business:
- It helps calculate COGS which is used to determine a company’s direct cost to manufacture products. It impacts the company’s profitability as well.
- It is used for cost flow assumption which is the process of moving the cost of a business’ product out of its inventory to its cost of goods sold
- FIFO formula provides accurate details on the inventory costing at a given time.
Definition of Each Element of FIFO Formula
- Cost of oldest inventory – It refers to the cost of the products companies purchased first out of the batch.
- Cost of number of inventory sold – This defines the total cost of the number of goods sold from the inventory.
Understanding with an Example
For example, X buys and resells tables. Here’s what it looks if X build up the inventory in the store:
Now, X sold 80 tables in April. So, COGS calculation using FIFO method is as follows,
= 80 x ₱50
FIFO method formula helps e-commerce businesses value inventory and calculate the COGS value.