FIFO Calculator for Inventory
The FIFO calculator for inventory and costs of goods sold (COGS) is an intelligent tool that can help you calculate your current inventory valuation, as well as the amount you have to report as COGS by considering the first-in, first-out (FIFO) method.
This article will cover what the FIFO valuation method is and how to calculate the ending inventory and COGS using FIFO. We will also discuss how investors can interpret FIFO and use it to earn more.
What is FIFO?
First-in, first-out (FIFO) is a method for calculating the inventory value of a company considering the different prices at which the inventory has been acquired, produced, or transformed. It also determines the cost of the goods when being sold.
First, it is essential to recall how a typical business operates:
The company buys inventory such as steel, microchips, shoes, adds value to the raw materials, and produces a good that they can sell. For acquiring such inventories, a company uses cash, but it can also get these products on credit. The company's financial statements includes the latter under the heading accounts payable.
The company then sells the product at a certain price over its cost of manufacture to earn a profit. Companies call this cost, cost of goods sold (COGS). Normally, the larger the revenue, the larger the profit.
The company receives its payment for the products sold (including any sale given on credit), pays its vendors, and with the remaining cash, re-start the process.
The above process has the following name: cash conversion cycle (CCC), and will be vital for understanding the applications of the FIFO method calculator.
During the CCC, accountants increase the inventory value (during production), and then, when the company sells its products, they reduce the inventory value and increase the COGS value.
But, again, what is FIFO?
When a company buys inventory, it does not make it at a single time. Similarly, the company does not sell all its inventory in a single batch. Typically, companies buy their resources for creating their products at different prices over time. Then, the question is: how to calculate the ending inventory value that accountants have to record on the balance sheet? That's where FIFO becomes useful.
FIFO — first-in, first-out method — considers that the first product the company sells is the first inventory produced or bought. Then, the remaining inventory value will include only the products that the company produced later. Regarding the costs of goods sold, we will mention it below.
There are other valuation methods like inventory average or LIFO (last-in, first-out); however, we will only see FIFO in this online calculator.
How to use FIFO for ending inventory calculation?
As mentioned above, accountants have to record the value of the inventory when it is acquired. Let's consider they do it this way:
Number of units purchased 1st time
p1 = 1st units purchased price
Number of units purchased 2nd time
p2 = 2nd units purchased price
qi = Number of units purchased last time
pi = Last units purchased price
Then we have:
Inventory value = (p1 * q1 + p2 * q2 + ... + pi * qi)
Here, we are assuming the company has not sold any product yet. Please note how increasing/decreasing inventory prices through time can affect the inventory value.
To calculate the ending inventory value, we have to discount the value of the items the company has sold, and because we are using FIFO, the first ones they sold will be the first ones they acquired. Assume we have sold
n items. In our notation, we will sell:
Number of units purchased 1st time
Number of units purchased 2nd time
Number of units purchased 3rd time
...and so on, until the number of sold items is equal to
If you wonder how much is your inventory value, you can use our great online FIFO calculator to find it out.
How to use FIFO for costs of goods sold calculation?
Once we know how many items we sold, we will start deducting them from our inventory. We only have to remember that FIFO assumes we are selling the first items we bought at their respective prices. Let's see an example considering the last-mentioned variables:
q₁ = 100 units
p₁ = 10 USD
q₂ = 110 units
p₂ = 15 USD
…meaning, we have an initial:
Inventory value = 2650 USD
Suppose we sell 150 units. With FIFO, we therefore sold all
100 units purchased at 1st time and
50 units purchased 2nd time. The COGS would be:
COGS = 100 units x 10 USD + 50 units x 15 USD
COGS = 1750 USD,
and the remaining inventory value will be:
Ending inventory = Inventory value - COGS
Ending inventory = 900 USD
Note that this is precisely the value of
60 remaining units purchased 2nd time:
60 units × 15 USD = 900 USD
You can use our online FIFO calculator and play with the number of products you sold to determine your COGS.
How to use the FIFO calculator?
Regarding how to get the cost of goods sold using our FIFO calculator, you need to follow the following steps:
- Add your acquisition price for each of the inventory batches.
- Include their respective quantities.
- Define how much inventory you will sell.
- Our FIFO calculator will indicate the remaining inventory and the resulting COGS.
How does the FIFO method affect taxable profits?
Let's first remember that a company is taxed on the profits after deducting any production costs (COGS), operating expenses, and any interest on existing debts.
Then, how much you record as COGS will impact the net profit margin. If COGS shows a higher value, profitability will be lower, and the company will have to pay lower taxes. Meanwhile, if you record a lower COGS, the company will report a higher profit margin and pay higher taxes.
How does the FIFO method affect a company's financial ratios?
As you may have noticed above, with the FIFO method, the ending inventory value will mainly depend on the price change of the units bought over time.
Prices of supply or products can vary significantly due to inflationary economic pressures. A similar case would occur in a deflationary period. Thus, any financial analysis an investor can conduct might be misleading. Let's look at an example:
Do you remember the formula of the days inventory outstanding (DIO), which indicates, on average, how many days a company needs for transforming its inventory into sales? Well, it is:
DIO = (average inventory / cost of goods sold) * 365 days
Notice how DIO would increase because of higher inventory and lower COGS, which is precisely what happens when we use the FIFO method during an inflationary period.
During inflationary times, supply prices increase over time, leaving the first ones to be the cheapest. Those are the ones that COGS considers first; thus, resulting in lower COGS and higher ending inventory.
CCC = DIO + DSO - DPO
Because DIO is more extensive due to higher remaining inventory value, the CCC will result in longer days, meaning the company is less efficient. This situation might not necessarily be the case, and it could be just the inflationary effect and the chosen accounting method.
Other financial indicators that will be affected by a higher inventory valuation will be: the current ratio, quick ratio formula, and debt to asset ratio. All of them indicate a better financial position for a company if the inventories (part of the current assets of a business) are bigger.
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How to calculate ending inventory using FIFO?
When you want to calculate the ending inventory value using FIFO, follow these steps:
- Accountants record the number of units acquired and their price each time separately from subsequent purchases.
- The combined value of the total units acquired, multiplied by their value, results in the inventory value.
- Register the number of items you have sold.
- Discount the number of items you have sold from the initial items you have bought. If you sell more items than the first purchase, discount the items of the second purchase, and so on until you discount all the products you have sold.
- As per the FIFO method calculation, the ending inventory value will be represented by the remaining inventory left multiplied by its acquisition price.
How to calculate COGS using FIFO?
Once we know how many products were sold, we discount them from the former inventory acquisition. For example, if we bought ten items at $100 each, and then another five items at $110 each, our inventory value will be 10 × $100 + 5 × $110 = $1550. Then, if we sell 12 items, COGS will be: 10 × $100 + 2 × $110 = $1220. Note how we consumed all the items from the 1st purchase, and then we took the remaining ones from the 2nd purchase.
How does inflation affect FIFO ending inventory calculation?
FIFO method calculates the ending inventory value by taking out the very first acquired items. Then, since inflation increases price over time, the ending inventory value will have the bulk of the economic value. As the FIFO method assumes we sell first the items acquired first, the ending inventory value will be higher than in other inventory valuation methods. The only reason for this is that we are keeping the most expensive items in the inventory account, while the cheapest ones are sold first.
Which financial ratios does FIFO ending inventory calculation affect?
FIFO calculation directly affects the ending inventory value, making it higher or lower than the average depending on whether inventory acquisition prices increased or decreased, respectively. Consequently, FIFO will affect all the financial ratios that consider inventories, current assets, and total assets. Some of them are the current ratio, cash conversion cycle, inventory turnover, inventory days, return on assets, quick ratio, and debt to asset ratio.
How does deflation affect FIFO ending inventory calculation?
FIFO method calculates the ending inventory value by taking out the very first acquired items. Then, since deflation decreases price over time, the ending inventory value will have less economic value. As the FIFO method assumes we sell first the firstly acquired items, the ending inventory value will be lower than in other inventory valuation methods. The reason for this is that we are keeping the cheapest items in the inventory account, while the more expensive ones are sold first.