What's the difference between FIFO, LIFO, and weighted average inventory methods?
FIFO stands for First In, First Out. It assumes the oldest inventory you purchased gets sold first. If you bought 10 units at $5 in January and 10 more at $7 in March, FIFO says the January units sell first. Your cost of goods sold reflects the older, lower price, and the inventory remaining on your balance sheet reflects the newer, higher price.
LIFO stands for Last In, First Out. It works in reverse. The most recently purchased inventory is assumed to sell first. Using the same example, LIFO would assign the $7 cost to the units sold. That means your cost of goods sold is higher, your reported profit is lower, and your tax bill shrinks when prices are rising. Sounds appealing, but there are trade-offs.
Weighted average takes all units available and blends the cost together. With 10 units at $5 and 10 at $7, your average cost per unit is $6. Every unit sold and every unit remaining gets valued at that blended rate. This method smooths out price swings and is the simplest to maintain, which makes it popular for businesses that buy large volumes of similar items at slightly different prices throughout the year.
The method you pick directly affects two things: how much profit you report and how your inventory shows up on the balance sheet. When costs are rising (which is the case more often than not), FIFO reports higher profit because you’re matching older, cheaper costs against current revenue. LIFO reports lower profit because it matches the most recent and higher costs first. Weighted average falls somewhere in between.
For most small businesses, FIFO is the default and most practical choice. It mirrors the actual physical flow of goods since you’re typically selling older stock before newer stock. QuickBooks Online supports FIFO and weighted average for inventory accounting, which is another practical reason most small business owners end up using one of those two.
LIFO is less common at the small business level. It’s not allowed under international accounting standards, and while US tax rules permit it, the IRS requires you to use it for financial reporting too if you use it for taxes. The record-keeping is more involved and most small business accounting software doesn’t natively support it. Unless your accountant specifically recommends LIFO for tax strategy reasons, it’s usually not worth the added complexity.
The most important thing is picking a method and sticking with it. Consistency matters both for accurate reporting and for staying in compliance. Switching methods mid-year creates confusion in your financials and may require IRS approval depending on the circumstances. If you’re not sure which method makes sense for your products and your margins, working with a bookkeeper in Long Beach who understands inventory can help you set things up correctly from the start so your cost of goods sold and profit numbers actually reflect how your business operates.
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