Inventory management is a crucial aspect of any business, as it directly impacts profitability and efficiency. One of the most widely used methods for valuing inventory and managing stock is the First-In, First-Out (FIFO) method.
FIFO assumes that the first items added to inventory are the first ones sold or used, making it a popular choice for businesses dealing with perishable or time-sensitive goods. Among the various methods used for restaurant inventory management, FIFO stands out as a fundamental method as it helps ensure freshness, reduce waste, and maximize profitability.
Today, we'll delve into the art of calculating FIFO for your restaurant's inventory, sharing practical insights that will help you keep your operation running smoothly and your customers coming back for more.
Understanding FIFO
Before diving into the calculations, it's essential to understand the FIFO principle.
FIFO works on the assumption that the oldest inventory items are sold or used first, meaning the cost of goods sold (COGS) is calculated using the cost of the oldest available inventory.
This method helps businesses align their accounting practices with the actual flow of goods.
In the context of a restaurant, this means using the oldest ingredients or products before moving on to newer ones.
The Importance of FIFO in Restaurants
There are many reasons that restaurants should implement the FIFO method:
- Freshness Matters
In the culinary world, freshness is non-negotiable. Using the FIFO method guarantees that you serve customers dishes prepared with the freshest ingredients. This enhances the quality of your food and sets you apart from competitors.
- Minimize Waste
FIFO reduces the risk of spoilage, ensuring that your perishable inventory doesn't sit on the shelf for too long. This makes it an effective way to minimize waste and save on business costs.
- Cost Control
By prioritizing the use of older stock, you avoid buying excessive quantities of new inventory. This helps control your expenses, ultimately leading to higher profit margins.
Tips for Using the FIFO Method
When using the FIFO method, there are a few steps you can take to help ensure ease of application and accuracy of information.
- Labeling and Organization
Ensure that all your inventory items are clearly labeled with the date of receipt and organize your storage areas so that the oldest items are easily accessible and used first. This will help ensure you are using the right products first, allowing for accurate calculations and maximizing the benefits produced by FIFO.
- Record Transactions
To calculate FIFO accurately, you need to maintain a detailed record of all inventory transactions. This includes the date of purchase, the quantity of items, and the purchase price for each batch or unit. Use a digital inventory management system or old-fashioned pen and paper to record these details.
How To Calculate FIFO: A Step-By-Step Guide
Now that you know the FIFO basics let's dive into the practical steps of calculating important inventory metrics using FIFO. Before you begin, you will need to gather the relevant information for the calculations.
- Beginning Inventory: This is the quantity and cost of items in inventory at the start of the period.
- Purchases: Record all purchases made during the accounting period, including the quantity and cost of each purchase.
- Sales: Keep track of the quantity and value of items sold or used during the period.
Calculate Ending Cost Of Good Sold Using FIFO
Let’s take a look at how to calculate Cost of Goods Sold (COGS) using FIFO. Before we get started, you will need some sample data. Let’s use the following to show these calculations in action.
- Beginning Inventory: At the beginning of this month you had 50 chicken breasts. You bought them on the 28th of last month for $5 each. That means your beginning inventory value is $250 (50 X $5).
- Purchases: On the 1st of the month, you purchased 100 chicken breasts for $4 each. On the 20th of the month, you purchased an additional 50 chicken breasts for $6 each. That means your total purchases are $700 ((100 X $5) + (50 X $4))
- Sales: This month you sold 75 chicken breasts.
Now that you have the data, it’s time to calculate COGS. To calculate COGS, follow these steps.
1. Sort the inventory items by purchase date in ascending order, with the oldest items at the top of the list.
Example
Last Month of the 28th: 50 chicken breasts at $5 each = $250
This Month on the 1st: 100 chicken breast at $4 each = $400
This Month on the 20th: 50 chicken breasts at $6 each = $300
2. For each sale or usage during the period, allocate the cost based on the oldest inventory items first, followed by the second oldest item, then the third and so on.
Calculate the cost of goods sold (COGS) as follows:
COGS = (Quantity Sold * Cost of Oldest Inventory Item) + (Quantity Sold X Cost of Second Oldest Inventory Item) + (Quantity Sold X Cost of Third Oldest Inventory Item).
Example
Because you sold 75 chicken breasts this month, you will have to do the COGS equation two times. Once for the first 50 items at a cost of $5 and once for the remaining 25 items at $4.
COGS = (Quantity Sold X Cost of Oldest Inventory Item) + (Quantity Sold X
Cost of Second Oldest Inventory Item)
COGS = (50 X $5) + (25 X $4)
COGS = $250 + $100
COGS = $350
This means that your total COGS for the current month was $350.
Calculating Ending Inventory Using The FIFO Method
Now that you have the COGS, you can calculate your ending inventory. Your Ending Inventory is the cost of the remaining inventory and is determined using the following equation:
Ending Inventory = Beginning Inventory + Purchases - COGS
Example
Continuing with the same example, your beginning inventory was $250 and your purchases for this month totalled $700. You calculated your COGS at $350.
Ending Inventory = Beginning Inventory + Purchases - COGS
Ending Inventory = $250 + $700 - $350
Ending Inventory = $950 - $350
Ending Inventory = $600
That means your ending inventory for this month is $600, which will also be the beginning inventory for next month.
Simplifying These Calculations
These FIFO calculations are important to maintaining proper records, but as you likely guessed, doing this over and over again for each and every item can get time consuming and is often rife with errors.
To help simplify the process, consider using inventory management software for your bar or restaurant. This software will keep track of all the important information, as well as calculate COGS, Ending Inventory, Beginning Inventory and other important inventory metrics for you. This not only saves time but helps ensure your data is accurate for better decision making.
Need help to achieve improved restaurant inventory? Get in touch with Sculpture Hospitality today.
