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September 2018

FIFO method explained

A Look at FIFO (First in First Out) Inventory Valuation Method

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Among the many inventory valuation methods you can use to determine your cost flow, one method stands out. This method is called First in First Out or FIFO for short. In this article, we’ll explain what FIFO is and how it works.

What is FIFO?

FIFO is a cost flow hypothesis that the first item bought should also be the first that gets sold. This is in fact in theory the most accurate inventory valuation method as for most companies, this matches their actual flow of goods the most.

According to FIFO, the first item that the company buys (first in) is also the first to be sold (first out). What this means is that the cost of older inventory gets assigned to the cost of sold goods, while the cost of newer inventory gets assigned to the ending inventory. As a result, the items left in the inventory are accounted for at the cost they were last obtained for and the asset recorded on the balance sheet will most closely match the actual cost for which it could be purchased in the market.

How does FIFO Work – an Example

So how does FIFO work in practice? Let’s take a company, we’ll call it Gothic and how they might estimate their inventory value for the period between 1st and 30th September.

Sep 1 Beginning Inventory 50 items @ $20.00 per unit
5 Sale 15 items @ $17.50 per unit
11 Purchase 25 items @ $16.00 per unit
17 Sale 30 items @ $22.00 per unit
23 Purchase 20 items @ $17.50 per unit
26 Purchase 50 items@ $20.50 per unit
29 Sale 75  items @ $21.00 per unit

Okay, let’s take a look at what we got here:

Units Available for Sale = 50 + 25+ 20+ 50 = 145
Units Sold = 15+ 30+ 75 = 120
Units in Ending Inventory = 145− 120 = 25
Cost of Goods Sold Units Unit Cost Total
Sales From Sep 1 Inventory 50 $20.00 $1,000
Sales From Sep 11 Purchase 25 $16.00 $400
Sales From Sep 23 Purchase 20 $17.50 $350
Sales From Sep 26 Purchase 50 $20..50 $1,025
145 $2,775
Ending Inventory Units Unit Cost Total
Inventory From Sep 29 Sale 25 $20.50 $512.5

Difference Between FIFO and LIFO

A comparison between FIFO and another inventory valuation method called LIFO presents itself automatically. So, what is different here?

Unlike FIFO, which, as we already explained, looks at the oldest items first for expense, LIFO does this with the most recent ones instead.

We’ll get more into LIFO and how this method is calculated another time. For now, just remember that FIFO and LIFO methods will give you different inventory and cost of goods sold (COGS).

Problem with FIFO

The biggest issue with FIFO is that, since it starts to expanse at the beginning of the inventory, it doesn’t match the income statement quite so well. This results in the revenue from the sale being often matched with a cost that is outdated.

For instance, if our company would purchase two trucks, one at $75,000 and the other at $90,000, under FIFO the sale of one of them would lead to an expense of $75,000, which is an outdated cost.

Conclusion

First In First Out method is the most natural inventory valuation method there is, which is why so many companies (including imaginary ones like ours) use it. That being said, it is not without it’s flaws, as we’ve seen.

What do you think of FIFO? Do you use this method or some other? Let us know in the comments below and don’t forget to sign up for a free Purchase Order Plus trial.

pros and cons of dropshipping

Does Dropshipping Work? Pros and Cons of Dropshipping

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If you are looking to start an online retail business one option you have is to start dropshipping. However, dropshipping is not for everyone and it comes with both advantages and disadvantages. Here are the main pros and cons of dropshipping you should know about before embracing this business model.

Pros of Dropshipping

First, let’s hear the good news and what are the pros of dropshipping.

  1. Lower Overall Risk

As a retailer the biggest problem for you will be the need to sell all of the inventory you have in stock. What you don’t manage to sell just becomes an expense and you don’t want that. With dropshipping, these risks are gone as you get to aling your store with what your customers really want and you pay only for what you sell.

  1. Low Inventory Cost

If you own a warehouse you’ll find the cost of keeping your own inventory to be one of your primary money-suckers. But in a typical retail fulfillment model, there’s no way around this. Dropshipping enables you to focus more on building your brand and strengthening your connection with the customers instead of wasting time and money on these issues.

  1. Lower Startup Costs

Starting a retail business is not cheap.Even before you really have customers, you need to have a significant inventory and that requires a good deal of capital. This means you are getting into a big risk. What if the customers don’t like or want or need what you are selling? You’ll end up with a full warehouse of items you can’t do anything with. With dropshipping you don’t need to have starting inventory. Once you find customers, you can start thinking about inventory.

  1. You can Offer a Wider Variety of Products

With dropshipping you can offer a larger variety of products to your customers and not worry about warehouse space and overhead costs. Think about it. What do customers want the most? More choices.

Okay, those were the pros, now let’s talk about the cons of dropshipping to give you a full picture.

Cons of Dropshipping

  1. It’s Highly Competitive

You didn’t really think you were the only one to think about this did you? Dropshipping has been around for years now (since 2006) and dropshippers come and go all the time because it is so highly competitive. It all comes down to lower entry capital. True it’s lower for you, but also for everyone else, so get ready for some tough competition.

  1. Profit Margins can be Very Low

Great, now need to stock inventory, low entry cost, low overhead. Sounds like a perfect deal. But guess what else is low. Profits. As a dropshipper, most of the money won’t go your way, but toward the wholesaler who supplies the goods. You need a lot of orders just to get above zero and make some profit. And then you need to start thinking about how to manage sales orders, marketing expenses, keeping your own website and all that stuff.

  1. You’ll Have Less Control Over the Supply Chain

You win some, you lose some. If you hand over the reins to someone else, you lose much of the control over the carriage and that’s exactly what happens here when you let someone else handle your shipping process. What if the supplier screws up the shipment? Who will the customer blame, you or him?

  1. Potential Legal Problems

Most new dropshippers think it all comes down to finding the cheapest supplier. But what if that supplier is not legitimate? A lot of wholesalers come from way of China and Asia and there’s usually no telling where they got their inventory from. Also, what if the supplier uses a trademark or logo that is not his? The moment you try to sell these items, you become complicit. The best way to avoid this is to use a Dropshipping Agreement Contract.

Conclusion

As you can see, dropshipping is not all black or white. It has both advantages and disadvantages, like any other business model. Hopefully, you now understand the pros and cons of dropshipping and what you’re getting into.

Do you have any questions or comments about the pros and cons of dropshipping? Let me know below the articles and don’t forget to sign up for a Purchase Order Plus free trial.

dropshipping explained

Here’s What You Need to Know About Dropshipping Before You Start

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If you are working in retail or have an online business, you probably heard of dropshipping. For the past few years, this has been a buzzword in the world of online business and retail (just take a look at Ecom Empires for refference), much like AI in programing or Khabib Nurmagomedov in MMA. But what is dropshipping (or drop shipping, however you want to write it)?

What is Dropshipping?

Dropshipping is a retail fulfillment method in which the seller doesn’t stock product it sells in a warehouse of its own. Rather, you buy the item you have an order from the customer from a 3rd party, usually a wholesaler. This wholesaler then ships the product directly to the customer.

You’ll probably agree that this is much faster than if the wholesaler sends the item to you and you to the buyer. In fact, as the seller, you never have any contact with the product itself.

Today, dropshipping is a highly profitable business (as you can learn from numerous success stories on the Internet, but it really became popular about 12 years ago when AliExpress gained a foothold in America. Before 2006, most people never even heard of this term, let alone considered that it might earn them a ton of money. Once people began to understand the benefits that this business model brings, such as low entry cost, it took on like wildfire to such an extend that huge ecommerce businesses such as Zappos are now basically dropshipping businesses or at least base their business around it.

What’s the Difference Between Dropshipping and Standard Retail?

The main distinction between a dropshipper and a standard retailer is that the first doesn’t own the product he sells, while the retailer does. That means the dropshipper doesn’t keep items in a warehouse or otherwise stock his inventory.

Instead, the dropshipper buys the product when he needs them from a wholesaler or directly from the manufacturer and fulfills orders that way.

Is Dropshipping for You?

You likely heard many successful dropshipping stories and thought “okay, if they did it, I can do it to”. But to every success story, there is at least one flop. You see, dropshipping is not easy, not quick and not for everyone. Think carefully before you jump the bandwagon.

If you are looking for a low-risk, low-investment way to earn money online, dropshipping could be the right choice for you. It’s also a pretty good starting business for novices or someone who already has a store, but wants to try selling a new item they typically don’t keep in stock. That way, the risk is significantly lower if it turns out the customers aren’t interested in that particular item.

On the other hand, if you are thinking about starting dropshipping because you are looking for a quick buck, then this business model is probably not for you. Another thing that might pull you away from it is the fact that you’ll have  much less say regarding customer satisfaction since they’ll be in as much contact with the wholesaler (who’ll send them the item) as they’ll be with you.

Conclusion

Okay, I hope this article helped you understand dropshipping a bit better and whether it is something you want to pursue. If you have any questions, please let me know in the comments below. Also, if you haven’t already, sign your email to try Purchase Order Plus software for free. POP will help you handle purchase orders much easier on  your mobile devices.

9 inventory management tips to save your business

9 Inventory Management Tips that Might Just Save Your Business

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Since there are no two companies with exactly the same inventory and stock or the same supply chain, inventory management is therefore different from company to company. That said, you should strive to customize your inventory management system in such a way that it minimizes human error and maximizes productivity. Here are 9 inventory management tips that might just save your business and increase cash flow.

1. Plan for the Worst

Things rarely work out exactly as you plan them in your head. The same goes for inventory management, needless to say. Don’t think if something will happen, but when it will happen. This way, when the problem does occur, it won’t take you by surprise and you will be ready to tackle it.

Be sure to know the risks that are in front of you and the problems that might arise. For example, the manufacturer might run out of the product just when you need it to fill the orders. Or, you run out of warehouse space. Here, it pays out to ask a question, “what is the worst that could happen” before starting a new enterprise, just like stoics do.

2. Know Who is Responsible

Inventory management should be done ad-hoc. You need to have a person responsible for it. Whether that person is you, if you’re the owner or you hire a professional inventory manager is up to you and will depend on the size of your business, how big your inventory and stock are, the size of your purchase orders, how many clients and vendors you have and so on.

The important thing here is to have someone you can wake up in the middle of the night (please don’t do that literally) with a question about the state of your inventory and get an accurate answer.

3. FIFO

FIFO or First In First Out is one of the key principles of inventory management where the oldest stock (first in) gets sold first (first out). This is an important principle you should hold on to if you have product that are susceptible to spoilage such as food.

That said, FIFO can be used for non-perishables as well. For example, new mobile phone models are released every few months. If you have a stock of them in your warehouse, you need to move them quickly as they will lose value the longer you keep them (customers are looking for new and better models).

Interestingly enough, FIFO is also used in computing, where it represents a method for organizing and manipulating data buffers. Namely, the oldest (first in) needs to get processed first (first out).

FIFO won’t work if your warehouse is not adequately organized. If you’re running your own warehouse, be sure to add a new product from the back and move old ones to the front.

4. Valuable Product Prioritization

Not all your products are equal. Some will simply get you more money than others. That’s basically the Pareto principle in action, which in this case, means that 80% of demand will be generated by just 20% of your products.

It is with these 20% that you need to put your focus the most. Then the next 30%, which will generate 10% less and finally, the remaining 50%, which typically generate only 10%. Of course, don’t take these percentages too literally, maybe it won’t be 20%, but 15% of 25%, but the principle is the same.

5. Set Par Levels

A “par level” represents the lowest amount of the product that you must have on hand and it’s a good thing to set them for all of your products. This gives you enough time to order more when you see that you are soon going to run out of stock.

Par-leveling does requires some upfront research, but it will make your inventory management considerably easier and allow you to make decisions about the product quicker. Of course, keep in mind that you don’t always need to order the same amount. Keep in mind the seasonality and other factors before you set par levels.

6. Audit on  Regular Basis

Be sure to audit your inventory regularly. This is important if you want to know whether all your reports (warehouse and others) match. Here are a few methods that will help you with this:

  • Spot checking

Spot checking involves choosing a single product, counting it and comparing to what you should have. This is a very good method if you do a full physical inventory and have a lot of products or often run into problems (such as low stock).

  • Physical inventory

Many businesses count all their inventory at once at the end of the year since this ties in with filing income tax. The problem with this method is that, if you have a lot of products, doing physical inventory can be very time consuming. Also, if you do find an error, it will be very hard to deduce where it came from just from an end-year inventory.

  • Cycle counting

The first two methods mean doing a full physical inventory, but that might not always be the best choice for an inventory audit. Instead, what you can do is use cycle counting and check  a different product at the end of the week or month. Typically, you want to count the higher value items more often than lower value ones.

7. Think About Dropshipping

You’ve probably heard someone say they are opening a dropshipping business or that they are running one (and often making a lot of money) and wondered, what is dropshipping? Basically, dropshipping differs from other retail fulfillment methods in that you don’t keep the products you sell in the stock, but buy them off from a third-party (usually a wholesaler), who then ships the product directly to the customer. That way, you don’t have to handle any inventory and can concentrate on acquiring customers.

You might be wondering, why doesn’t the wholesaler sell the product himself? One reason for this is that the wholesaler may not have the customer-acquiring, product promotion or selling tools that you do, so this is usually a win-win situation for both.

8. Have an Action Plan for Excess Stock

Poor sales forecasting inevitably leads to excess stock. To prevent this, you need to have two “task forces”. One will be responsible for selling off that excess inventory, while the other looks for the cause of this inefficiency. Of course, these two task forces need to communicate well, otherwise the whole plan will be liable to failing.

9. Accurate Forecasting

Accurately predicting demand is an important part of inventory management. A couple of thing that you need to consider when forecasting your future sales are:

  1. Market trends
  2. Growth year this year
  3. Guaranteed sales (subscriptions and contracts)
  4. What were the sales like last year on the same week or month
  5. Upcoming promotions
  6. Product seasonality
  7. Overall economy (consider both local and global economy if you sell internationally).

There are many other ways to improve your inventory management, but these 9 inventory management tips should help you operate a more effective supply chain, improve your cash flow and run a successful business. So don’t waste time and implement these tips today.

Do you have any questions or have any other inventory management tips to share? Let’s hear from you in the comments below and don’t forget to sign up for a free trial for Purchase Order Plus.