FIFO, LIFO, FEFO Methods in Inventory Control

Optimize inventory control with FIFO, LIFO, FEFO Methods. Prioritize profitability and product quality. Learn their benefits and choose the right strategy.

Introduction

To establish the sequence in which products are sold or used, FIFO, FEFO, and LIFO are three separate approaches used in inventory management, warehouse management, and pharmacy management.

What is FIFO?

FIFO stands for “First In, First Out,” which means that the first thing that is kept in a warehouse or store will be the first item to be used or sold. This approach is frequently used in inventory management to reduce waste and lower the risk of obsolescence.

Guidelines for FIFO

“A method to ensure stock rotation (“first in first out”) with regular and frequent inspections that the system is operating effectively,” according to the recommendations on acceptable distribution practices for pharmaceuticals intended for human use (94/C 63/03), which are no longer in force.

“The statement noted that, “All salable products returned to stock should be placed in such a manner as to properly follow the ‘first in first out’ procedure.”

What is LIFO?

The “Last In, First Out” (LIFO) principle states that the last thing held in a warehouse or pharmacy will be the first item to be used or sold. As it serves to lower the danger of obsolescence, this strategy might be helpful in inventory management for products with limited shelf lives.

Guidelines for LIFO

The WHO’s “Good Storage and Distribution Methods for Medicinal Items” (Annex 7, WHO Technical Report Series 1025, 2020) mentions LIFO.

Difference between FIFO, FEFO, and LIFO

What is FEFO?

The FEFO Principle, which stands for “First Expired, First Out,” is utilized only for perishable commodities, including food, medications, and prescription medications. The FEFO approach makes sure that the oldest things are used or sold first, which reduces waste and lowers the danger of obsolescence.

Guidelines for FEFO

The EU GDP Guidelines (Guidelines on Good Distribution Practice of Medicinal Products for Human Use, 5 November 2013/C 343/01) favor the FEFO strategy. “As per the “first expiry, first out” (FEFO) principle, the goods stock should be rotated,” is stated in Chapter 5.5 (Storage). Exceptions need to be documented.

In Chapter 6.3 (Returned Medicinal Products), it is mentioned that “Products sold back in stock should be arranged in such a way that the ‘First Expired First Out’ (FEFO) system operates consistently.”

The WHO states in Annex 7 of their WHO Technical Report Series 1025, published in 2020, that “Materials and health products should be stored in a manner that assures the maintenance of their quality. It is important to rotate stock properly. Following the “first expired/first out” (FEFO) rule is recommended.

Related: GxP in The Pharmaceutical Industry

Differences Among FIFO, LIFO and FEFO

FIFO, LIFO, and FEFO are three different methods used in inventory control and management to track the flow of inventory items and calculate the cost of goods sold (COGS). Each method has its own advantages and disadvantages, and the choice of which method to use depends on the specific needs and circumstances of a business.

FIFO (First-In, First-Out)

1. FIFO is based on the principle that the first items added to inventory are the first ones sold or used.

2. Under FIFO, the cost of goods sold (COGS) is calculated by using the cost of the oldest (first-in) inventory items.

3. FIFO tends to match current costs more closely with current revenue, making it a good choice for businesses with perishable or rapidly changing inventory, such as food or electronics.

4. It results in a more accurate reflection of the current value of the remaining inventory on the balance sheet.

LIFO (Last-In, First-Out)

LIFO assumes that the most recently acquired inventory items are the first ones sold or used. Under LIFO, the cost of goods sold (COGS) is calculated using the cost of the newest (last-in) inventory items.

LIFO can be beneficial for tax purposes as it often results in higher COGS, which leads to lower taxable income and lower income tax.

However, LIFO may not reflect the actual physical flow of inventory, and it can lead to issues during times of rising prices as it can overstate the value of ending inventory.

FEFO (First-Expired, First-Out)

FEFO is primarily used in industries where product expiration or spoilage is a significant concern, such as pharmaceuticals or food. It ensures that items with the earliest expiration dates are used or sold first to minimize waste.

Under FEFO, the cost of goods sold (COGS) is calculated using the cost of the oldest items that have expired.

While it helps in reducing waste and complying with regulatory requirements, FEFO may result in higher COGS, which can affect profit margins.

The Pros (Advantages) and Cons (Disadvantages) of FIFO, LIFO and FEFO

FIFO (Fast-In-First-Out), LIFO (Last-In-First-Out), and FEFO (First-Expired-First-Out) are methods used in inventory control and management. Each has its own advantages and disadvantages, which can impact a business’s financials, tax liabilities, and overall inventory management.

FIFO (First-In-First-Out)

Pros (Advantages):

1. Accurate financial statements: FIFO typically results in more accurate financial statements as it matches older, lower-cost inventory with sales, reflecting a company’s profitability more accurately.
2. Lower risk of inventory obsolescence: Since older inventory is sold first, there’s a lower risk of items becoming obsolete.

Cons (Disadvantages):

1. Higher taxes: FIFO often results in higher taxable income and, consequently, higher income tax liabilities.
2. Potential mismatch with current market prices: In periods of inflation or rising costs, FIFO may overstate a company’s profitability because it values the cost of goods sold with an older, lower-priced inventory.

LIFO (Last-In-First-Out)

Pros (Advantages)

1. Tax benefits: LIFO can result in lower taxable income because it assumes that the most recently acquired items are the first to be sold, which often have higher costs. This can reduce income tax liabilities.
2. Matching current costs: In periods of rising prices, LIFO matches the cost of goods sold with current market prices, providing a better reflection of the company’s profitability.

Cons (Disadvantages)

1. Distorted financial statements: LIFO can distort a company’s financial statements, making it appear less profitable, which can affect investors’ perceptions and access to capital.
2. Inventory obsolescence: Older inventory items may become obsolete or have to be sold at a loss, as they remain in stock longer.

FEFO (First-Expired-First-Out)

FEFO is a specialized inventory management method commonly used in industries where products have expiration dates, such as food and pharmaceuticals. It ensures that items with the earliest expiration dates are sold first.

Pros (Advantages)

1. Minimizes waste: FEFO helps minimize waste by ensuring that products with shorter shelf lives are sold before they expire.
2. Maintains product quality: It helps maintain product quality and safety by reducing the risk of selling expired items.

Cons (Disadvantages)

1. Complex tracking: Implementing FEFO requires meticulous tracking of expiration dates, which can be administratively demanding.
2. Potential for higher holding costs: FEFO can lead to higher holding costs if products with shorter shelf lives are kept in inventory longer, especially if demand is low.

Conclusion

In conclusion, the sequence in which products are sold or utilized is determined using the FIFO, FEFO, and LIFO procedures in inventory management, warehouse management, and pharmacy management. The particular requirements and features of the objects being managed will determine which approach should be taken

Frequently Asked Questions (FAQs)