Some Background Information on FIFO
For a business that sells physical goods, inventory is one of the most important balance sheet line items. However, with fluctuating per-unit costs and a growing catalog, accurate inventory accounting can be a nightmare. This nightmare is further complicated when inventory isn't generally handled by the business but is instead managed through a 3PL like Amazon FBA. With this complexity many Amazon sellers resort to estimating their inventory value using an average cost approach which can work in many cases but can also lead to glaring inaccuracies if average per-unit costs are not regularly re-calculated. To solve this problem, Ecominate has created the first Amazon FBA compatible FIFO based inventory accounting system. This article introduces FIFO's benefits and how it is implemented in Ecominate. The setup is front-loaded but once your account is up and running you can be rest assured that you will save several hours every month while maintain an accurate valuation of your inventory that syncs directly with your accounting system.
How FIFO Works in Ecominate
FIFO COGS works by mapping a set of date-ordered purchase orders to a stream of inventory adjustments on a first-in first-out (FIFO) basis. Since Ecominate has a complete list of your purchase orders, we will match these purchases against the various inventory movements (i.e. shipped orders, returns, lost inventory etc.) that occurred inside the FBA network. This means that Ecominate will regularly reconcile your inventory against FBA and properly account for all of the various FBA inventory movements. You are then left with a new inventory valuation that accurately values all of the remaining inventory on a FIFO basis. Then for each month thereafter, Ecominate calculates a FIFO based month-end inventory value that accounts for all of the inventory adjustments and COGS for that month. Ecominate was built to compliment accounting systems like Xero and QuickBooks so once the setup is complete, Ecominate will regularly update your accounting system with an accurate account of your inventory. In order to get FIFO set up, Ecominate require a 5-step setup process. Below we briefly outline each step and link articles that elaborates on each step in more detail.
- Selecting a FIFO Starting Date - Ecominate requires a starting date for the basis of your starting inventory value.
- Creating a SKU to Product Mapping - Create a mapping between all of the instances of your SKUs/FNSKUs on Amazon and the Products you order from your suppliers.
- Creating Suppliers and add Products - Create your suppliers and add your products under them
- Entering your purchase orders - In order to get a starting inventory value, enter all of the recent purchase orders from your starting date all the way to the present day.
- Entering your starting inventory -
- Connecting to an Accounting System (Optional) - More on this later.
The Benefits of FIFO
First-In First-Out (FIFO) is an accounting and inventory valuation framework that assumed the oldest items of inventory are sold first and the newest are sold last or held as inventory. Put another way, FIFO matches the most recent sale with the oldest inventory. Although in practice the most recent sale will not always match perfectly with the oldest inventory item, this method offers several attractive operational benefits for e-commerce businesses. First, FIFO is typically the preferred and most widely recognized inventory accounting method used by accountants. FIFO is logical in implementation because it provides a set of rules for costing inventory that is purchased at different prices in different times. FIFO decreases the likelihood of financial statement manipulation by ensuring that the current inventory on hand more accurately reflects recent market values since the most recent inventory is costed only after older inventory has been sold. When FIFO is jointly implemented as an inventory management protocol, it can lead to a lower chance of obsolete inventory as older units are sold more consistently. In terms of Amazon FBA, FIFO is our preferred inventory accounting method because it offers far more accuracy than average cost when prices fluctuate. From an implementation perspective, you are no longer responsible for updating changing average costs with every purchase order.