FIFO method explained: How first-in, first-out impacts inventory, margins, and profitability

High performers must make smart, strategic decisions every day

If you’re in a business managing inventory, the method you choose to value stock influences your operations, cash flow, profit margins, and the reliability of your financial reporting.

One of the most widely used methods is First-In, First-Out (FIFO)—an inventory costing approach that assumes your oldest stock is sold first.

The FIFO method is widely used in manufacturing, where inventory costing can be complex. 

Take electronics for example. In today’s high-demand environment, using your oldest batch of microchips first isn’t simply common sense—it’s essential. 

Components can quickly become outdated, and holding onto excess inventory ties up capital and distorts financial accuracy. 

Manufacturers must track costs through multiple production stages, with variations in raw material usage, labor intensity, and energy usage. 

Despite this complexity, FIFO provides a consistent framework for valuing inventory across different production processes, helping maintain transparency and control over manufacturing costs.

That’s why many businesses use the FIFO method. 

FIFO is one of the most widely used inventory costing approaches because it aligns with how inventory typically moves through a business. 

Matching older stock to earlier sales reduces waste and ensures fresher product availability. You can produce financial statements that reflect current market conditions, which are critical for effective planning and strategic clarity.

In this guide, we define the FIFO method and show how it impacts key financial calculations, such as the Cost of Goods Sold (COGS) and ending inventory. 

Aim to understand why adopting FIFO could support you with high-performance inventory and financial management.

Here’s what we cover:

What is the FIFO method?

Cost of Goods Sold (COGS) is the direct cost of producing or purchasing the products your business sells. It’s subtracted from revenue to calculate gross profit. The FIFO method is an inventory costing approach that assumes the earliest goods purchased are the first to be sold. 

It is commonly used to track your COGS and accurately estimate the value of your remaining inventory at the end of an accounting period.

FIFO supports high-performance inventory management by: 

• Reducing obsolescence risk. Older inventory is sold first, minimizing waste and loss from expired or outdated goods.
• Simplifying inventory control. FIFO aligns with standard warehouse practices, such as stocking newer products behind existing inventory.
• Boosting financial transparency. FIFO provides a straightforward and auditable method for valuing inventory, supporting accurate gross margin calculations.

Operationally, FIFO is often reflected in warehouse workflows—for example, by organizing stock so that the oldest items are picked and shipped first (like in our microchips example).

You can align your physical inventory flow with your accounting to strengthen your operational and financial performance.

How FIFO works in accounting

What FIFO means

“First-in, First-out”— the cost of the oldest inventory items is used first when calculating the Cost of Goods Sold (COGS).

COGS impact

COGS reflects older inventory costs, which are typically lower during inflation. This can lead to higher gross profits being reported.

Balance sheet impact

Ending inventory is based on the most recent purchase prices, which are usually higher. This gives a more up-to-date valuation of assets.

Best for

Businesses with high inventory turnover or items that expire or go obsolete quickly—such as in food, fashion, technology, and pharmaceuticals.

Why it matters

FIFO provides a clear, auditable method that aligns with real inventory flow. It supports more accurate profitability analysis and often simpler regulatory compliance under GAAP and IFRS.

How to calculate FIFO

Calculating FIFO involves determining the Cost of Goods Sold (COGS) and the value of ending inventory based on your oldest inventory purchases. 

You’ll probably do this when preparing formal financial statements such as the income statement and balance sheet, but you can save time by automatically applying the FIFO principle to each sale in real time with financial management software.

However, it’s still helpful to understand the manual process for calculating FIFO, which you can do if you maintain detailed records of your inventory purchases, including the date, quantity, and cost per unit of each purchase.

Action	Details	Example calculation

1. Identify the oldest inventory batch

Find the earliest inventory purchases on record.

100 units purchased at $10 each.

2. Allocate units sold to the oldest batches

Apply sales first to the oldest batch. If sales exceed available units, move to the next batch.

Sell 100 units from the $10 batch. Then 50 units from the $12 batch.

3. Calculate COGS

Multiply units sold from each batch by the batch’s cost per unit. Sum these amounts to get the total COGS.

(100 × $10) + (50 × $12) = $1,600 total COGS.

4. Calculate ending inventory

Subtract units sold from each batch’s original quantity. Multiply remaining units by the original cost per unit. Sum these amounts for the total ending inventory.

50 units remaining × $12 = $600 ending inventory.

5. Apply FIFO formulas

COGS = (Units sold × Cost per unit) summed across batches. Ending Inventory = (Remaining units × Cost per unit) summed across unsold batches.

COGS: $1,600Ending Inventory: $600

FIFO example calculations—a basic inventory example:

You purchase:

• 100 units at $10 each
• 100 units at $12 each
• Total inventory: 200 units.

You sell 150 units. Using FIFO:

• First, sell the 100 units from the $10 batch:
• 100 × $10 = $1,000

Then, sell 50 units from the $12 batch:

• 50 × $12 = $600

Total Cost of Goods Sold (COGS):

• $1,000 + $600 = $1,600

Ending inventory:

50 remaining units from the $12 batch

Ending inventory value: 50 × $12 = $600

Real-world business examples of FIFO in action:

Grocery stores:

Staff stock new milk cartons behind older ones to ensure the oldest inventory (closest to expiration) sells first, reducing spoilage.

Clothing retailers:

Last season’s clothing sold before a new collection was introduced, helping to clear stock and maintain fresh inventory turnover.

Pharmacies:

Medications are rotated to sell those with nearer expiration dates first, preventing financial loss from expired products.

Technology retailers:

Older models of phones or electronics are sold before newer releases hit the shelves, minimizing inventory markdowns.

What are your main reasons for using FIFO?

FIFO is a straightforward and logical method that often aligns with the actual physical flow of goods. 

• FIFO records are a more accurate and transparent representation of your operations, making your financial statements more trustworthy.

• Closer alignment to true product flow means less room for inventory tracking and valuation errors. 

• FIFO is easier to understand and implement than some other costing methods. 

The FIFO method also reflects the current market value of inventory on the balance sheet, which is especially useful in times of inflation. 

For example, if you have older, lower-cost inventory selling at current-cost dollars, your profit may be exaggerated, leading to higher income taxes.

Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) accept the FIFO method. The IFRS requires FIFO in some regions.

Why FIFO matters, and why tech can help

If you’re managing finances for a product-oriented business, the inventory valuation method you choose directly impacts cash flow, profitability, tax liability, and your agility.

FIFO can provide you clearer visibility into margins, especially when supported with technology.

Operational efficiency and capital allocation

FIFO supports lean inventory practices by ensuring your older stock is sold first, reducing spoilage, obsolescence, and costly write-downs.

• Tech makes this scalable—with automation, you could consistently apply FIFO logic across your warehouses to optimize shelf life, reduce excess stock, and maintain accurate reorder levels. 

•  Look for better capital allocation and free up cash tied up in unsellable goods.

Enhanced customer experience and revenue continuity

By aligning inventory turnover with demand cycles, FIFO ensures your customers receive fresher products and current Stock Keeping Units (SKUs)—unique product codes that help track individual items and variations such as size, color, or model.

• Look for technology supporting real-time tracking and intelligent stock rotation, giving your operations and sales teams the confidence that product freshness and availability are managed automatically. Tech can track data accurately, giving you an up-to-the-minute view of all points along your inventory lifecycle so your decisions are made faster and smarter.

• Aim to build trust, drive repeat purchases, and protect long-term revenue by reducing last-minute discounting or outdated stock clearance.

Financial transparency and margin accuracy

Because FIFO is assigning the oldest (often lower cost) inventory to COGS, this will lead to higher reported profits during inflation. As a result, you’ll get a more accurate understanding of gross margins over time.

• When paired with financial management technology, FIFO data can flow seamlessly into real-time dashboards and reports—supporting faster, more informed pricing, sourcing, and cost control decisions.

Regulatory compliance and audit readiness

As a GAAP and IFRS-compliant method, FIFO simplifies audit preparation and regulatory reporting.

• Integrated financial systems can maintain clear FIFO audit trails, making it easier to generate supporting documentation, respond to compliance checks, and consolidate global financials across multiple entities.

Strategic insights and future planning

Inventory valuation influences everything from scenario planning to long-term investment strategy. 

FIFO provides a stable and intuitive foundation for forecasting, particularly when supported by tools that integrate inventory data with cash flow projections and supply chain analytics.

• With the right systems in place, you can gain continuous visibility into cost trends and respond smarter, more agilely to market shifts and volatility.

Final thoughts

Whether you’re managing microchips, milk cartons, or fast fashion, FIFO remains one of the most practical, widely adopted inventory costing methods for aligning your financial records with the real-world movement of goods. 

You can reduce waste, simplify compliance, improve margin visibility, and support long-term financial planning, agility, and resilience.

What sets high-performing companies apart is how they implement FIFO at scale—using financial management systems that can automate tracking, streamline reporting, and connect valuation data to broader business strategy.

With a time-tested accounting method and the right technology, you can unlock real-time visibility, tighten operational control, and drive better decision-making across the entire supply chain.