FIFO is an acronym for “first in, first out.” It refers to an inventory system that directs a firm to utilize the oldest items in inventory when a product or part is needed. Furthermore, it also helps ensure steady material flow, which is essential in any lean manufacturing process.
Four Benefits of a FIFO System
1. Steady Material Flow
A first in, first out system helps you avoid overproduction of a particular part. In addition, it prevents over-stuffing your system with intermediate products because a first in, first out system includes a production cutoff once you hit an inventory limit for a component. As a result, no part will “rot” within the system by waiting too long before you use it.
2. Lean Material Flow
Due to the cap on a FIFO “lane,” you will not overfill a particular system. Therefore, all types of waste will be limited. In particular, you prevent the worst kind of waste, which is over-production.
3. Improved Visual Management
It’s easy to see if a FIFO lane fills, which helps managers easily depict workflow in diagrams. Fortunately, bottlenecks become apparent because the upstream inventories are likely to fill.
4. Limits Information Management
The downstream processes do not need to communicate with upstream processes. The downstream processes merely have to use the parts in their inventory in the proper order. This structure reduces the information managers need to process while maintaining a steady material flow.
Reasons Why FIFO Is Important to Understand
Allows You to “Decouple” Processes
In a first in, first out system, the related processes do not have to communicate with one another to function. Instead, each discrete process only has to use inventory in the proper order to maintain efficient production or stop when the stock hits a defined limit.
Processes Aren’t Consistent
In a perfect world, each process would take a set amount of time. There would be no variations that can create temporary production problems. Each step would be perfectly predictable and never vary.
We don’t live in that world.
In real-world manufacturing, many factors can temporarily change production time for each step. These shifts can cause production problems and wreak smooth product flow.
Inventory Can Overcome Process Variance
Maintaining an inventory of each part can help overcome temporary process interruptions by allowing the system to continue at a normal rate until inventory runs out. This practice allows managers to “buy time” to solve the hang-up before suffering a production downturn.
Industry Example of a FIFO System
One classic example is a car assembly line, which has become standard since Henry Ford introduced it in the 1920s. Everyday examples outside of manufacturing might be a grocery store checkout line or a cue for the toilet. The latter example keeps any customer from waiting an extraordinary amount of time, which can be essential to limit their irritation.
Four Best Practices When Thinking About FIFO
1. Don’t Confuse FIFO Production with a FIFO Accounting System
Though they use the same acronym, a FIFO production system doesn’t require a FIFO accounting system. A business can use a FIFO production method in many situations while using a last in, first out (LIFO) accounting method.
2. Consider Each Major Step a FIFO “Lane”
Considering each intermediary step in the production process as a “lane” helps remind you that each process occurs concurrently instead of thinking of them as sequential. Parts move through a system in a sequence, but the processes run simultaneously.
3. No Part Should Overtake Another Part
The simple way to think about this rule is that parts shouldn’t “cut” the line. The reason you maintain this order is to prevent fluctuations in throughput time. If parts overtake one another, wait times for other parts can increase, creating extreme production disruptions.
4. Must Establish a Maximum Inventory for Each Lane
This rule is to avoid overproduction, which is the worst kind of waste in lean manufacturing. If too much stock builds up, downstream processes struggle to “clear” inventory, creating a permanent backlog of unused parts.
Frequently Asked Questions (FAQs) About FIFO Production
Why would a firm use a FIFO production method paired with a LIFO accounting system?
A last in, first out (LIFO) accounting system helps reduce book profits and may lower a firm’s tax liability. This benefit is particularly acute when inflation is high because rising material prices drive up “book” costs. However, remember that a LIFO accounting system doesn’t necessarily mean that the production side uses inventory in this manner. It’s possible to use stock following FIFO rules and account for parts using LIFO.
Are there times not to use a FIFO production system?
Yes. If you’re processing parts in batches, it will be challenging to maintain a strict order of the items in a group. Another example is when a firm has priority orders. Certain goods or services can have sharply different prices depending on the customer. If an order carries a hefty profit margin, processing these products ahead of others can increase revenue.
Are there disadvantages to using FIFO?
Yes. FIFO doesn’t work well when products have variable storage costs. For example, suppose your facility has limited inventory space, and any excess is stored in an outside warehouse at a premium price. A strict FIFO system increases costs and reduces profits. In other situations, FIFO might limit the efficiency of your machinery. For example, in injection molding, processing light-colored products before moving on to darker products regardless of production order can reduce the amount of cleaning the machine needs between batches.
In Most Cases, FIFO Maximizes Production Efficiency
Lean management is all about generating the highest possible profits from your efforts. Understanding how FIFO works and when it benefits or hinders your profitability can significantly affect your firm’s bottom line.