Secret Life of Inventory – Episode #26 – FIFO vs. LIFO vs. Moving Average: How to Choose the Right Inventory Costing Method

Did you know two businesses could buy from the exact same suppliers, sell the exact same products at the exact same prices, and still report completely different profits at the end of the year? Same sale, different numbers. How is that possible? The answer comes down to inventory costing methods (also called inventory valuation).

In the latest episode of Secret Life of Inventory, we break down the three most common valuation methods: FIFO, LIFO, and moving average. Watch the full episode below, or keep reading for a quick recap.

What is inventory valuation, and why should you care?

Inventory valuation is the practice of assigning a dollar value to the products sitting on your shelves. It sounds simple enough, but the method you choose has a direct impact on your cost of goods sold (COGS), your reported profit, and most importantly, your tax bill.

Before you even think about which method to use, you need to understand your true product cost. That’s not just what your supplier charges you; it’s your full landed cost, including shipping, customs duties, anything directly tied to getting the product ready for sale, but not everyday overhead like rent or utilities.

FIFO: the crowd pleaser

FIFO stands for first in, first out, and it works exactly how it sounds. The oldest inventory in your system gets sold first. Think of the milk at your local grocery store: older cartons sit up front, encouraging shoppers to grab those before the fresher stock in the back.

FIFO is by far the most widely used method. In a recent survey of 400 inventory operators, we found that half rely on FIFO. It’s especially popular in industries where expiration dates matter, like food and beverage or pharmaceuticals, but it also shows up in fashion, apparel, and electronics, where products can quickly become outdated.

LIFO: the tax-season darling

LIFO flips the script entirely. Instead of selling your oldest inventory first, last in, first out means the most recently purchased items get sold first.

On paper, LIFO can look pretty appealing during inflation since it usually reports lower profit (and a smaller tax bill). But there’s a major catch: LIFO is banned under IFRS, the global accounting standard. The only place you’re allowed to use it is the United States, under GAAP. Try to use it anywhere else, or misuse it in the US, and you could be forced to redo your books under a different costing method and be on the hook for any taxes you dodged, plus penalties.

Moving average: the middle ground

Rather than tracking separate cost “layers” like FIFO and LIFO do, moving average blends the cost of everything together. Every time you make a new purchase, your average cost per unit recalculates automatically.

This method smooths out price fluctuations, making it popular for industries with a lot of similar, non-perishable items, like wholesale, ecommerce, and construction. It’s also the default costing method built into most modern inventory software, since manually recalculating your average cost with every transaction would be a nightmare.

Which inventory costing method is right for you?

There’s no one-size-fits-all answer. The right method depends on how inventory actually flows through your business, whether your costs fluctuate often, what your industry peers are doing, and what your local accounting standards allow.

One rule applies no matter which method you land on: consistency. As appealing as it might be for businesses in the US to switch methods depending on what would benefit them during tax season, this is a big no-no. It’s recommended that you choose a method and stick with it. 

Now that doesn’t necessarily mean you need to pick a single valuation method and apply it company-wide. You can also mix and match costing methods for different SKUs. This means you can use the method that works best for each product. 

Let software do the heavy lifting

Trying to track FIFO layers or recalculate moving averages in a spreadsheet gets messy fast. Especially as your SKU count grows. This is where dedicated inventory management software earns its keep, automatically updating your costs in real time.

Want to see how FIFO, LIFO, and moving average stack up with real numbers? Watch the full episode of Secret Life of Inventory for the complete breakdown, including examples and tips on picking the right fit for your business.