How to Calculate Sales Revenue Using FIFO?
Master FIFO inventory costing to accurately calculate cost of goods sold and understand its impact on gross profit from sales.
Sales revenue represents the total income a business generates from selling its goods or providing services. It is a key figure on a company’s income statement, often called the “top line,” and is crucial for understanding financial performance. Inventory costing methods assign values to goods sold and those remaining in stock. The First-In, First-Out (FIFO) method directly influences financial reporting by assuming a specific flow of inventory costs.
Understanding FIFO Inventory Costing
FIFO, or First-In, First-Out, is an inventory valuation method that assumes the first units of inventory purchased or produced are the first ones sold. This assumption means that the costs associated with the oldest inventory are recognized as the Cost of Goods Sold (COGS) before the costs of newer inventory. While the physical flow of goods does not always have to match this assumption, FIFO is intuitive for businesses dealing with perishable goods or products with expiration dates, ensuring older stock is moved first.
The application of FIFO depends on the inventory accounting system a company employs: perpetual or periodic. A perpetual inventory system continuously tracks inventory balances and COGS in real-time, updating records with each sale and purchase. This system provides immediate insights into stock levels and costs.
Conversely, a periodic inventory system updates inventory and COGS only at specific intervals, such as the end of an accounting period. Under this system, businesses perform a physical count of their inventory to determine the ending balance. The COGS is then calculated based on this physical count and the cost flow assumption applied at that time. Regardless of the system, the core FIFO principle—that the earliest costs are expensed first—remains consistent.
Calculating Cost of Goods Sold Using FIFO
Calculating the Cost of Goods Sold (COGS) using the FIFO method involves applying the “first-in, first-out” assumption to the costs of inventory. COGS represents the direct costs attributable to the production of goods sold by a company, including raw materials, direct labor, and manufacturing overhead.
Under a perpetual inventory system, COGS is determined at the time of each sale. For example, consider a business with the following inventory purchases: 100 units at $10 each on January 1, and 150 units at $12 each on January 15. If the business sells 80 units on January 20, the COGS for this sale would be $800 (80 units x $10), as these are the oldest units in stock. The remaining inventory would then consist of 20 units at $10 and 150 units at $12. If another sale of 100 units occurs on January 25, the COGS would be calculated by taking the remaining 20 units at $10 ($200) and 80 units from the January 15 purchase at $12 ($960), totaling $1,160. This continuous tracking provides real-time COGS figures.
In contrast, the periodic inventory system calculates COGS only at the end of an accounting period. Using the same purchase data (100 units at $10 on January 1; 150 units at $12 on January 15), assume total sales for the period were 180 units. To calculate COGS using periodic FIFO, the 100 units from January 1 are assumed sold first ($100 x $10 = $1,000). The remaining 80 units sold would come from the January 15 purchase ($80 x $12 = $960). The total COGS for the period would then be $1,960 ($1,000 + $960). The ending inventory would be the remaining 70 units from the January 15 purchase ($70 x $12 = $840). This method provides a snapshot of COGS and ending inventory after a physical count.
Connecting FIFO to Sales Revenue and Gross Profit
Sales revenue is the total money earned from selling products or services before deducting costs. This figure is often referred to as net sales, which accounts for returns, allowances, and discounts. It forms the initial line item on an income statement, providing a measure of a company’s top-line performance.
Cost of Goods Sold (COGS), determined using the FIFO method, is subtracted from sales revenue to arrive at gross profit. The formula is: Sales Revenue – Cost of Goods Sold = Gross Profit. For instance, if a company has $100,000 in sales revenue and a FIFO-calculated COGS of $40,000, its gross profit would be $60,000.
Gross profit is a financial metric indicating how efficiently a business manages the direct costs of its production and sales. It reflects the profitability of a company’s core operations before considering other operating expenses like rent, utilities, or administrative costs. When inventory costs are rising, FIFO often results in a lower COGS, which leads to a higher reported gross profit. This higher gross profit can influence investor perception and impact other financial metrics, even though it may also result in higher taxable income in an inflationary environment.