FIFO, LIFO, or Weighted Average: Choosing the Right Inventory Valuation Method for Your Ecommerce Business

Elspeth From A2X (00:00)
Hey everyone, we're joined today by Phil Oakley from Outserve, one of the UK's top ecommerce accounting integrators. He works with Amazon and Shopify brands that you might recognise here in the UK, along with his team. In this video, we're going to talk about how to choose the right cost flow method for your ecommerce business. Your cost flow rules will decide which landed cost layers turn into the COGS every time you make a sale. We've got other videos on COGS which you might want to check out — we'll add those down in the description. But first of all, thank you for being here today, Phil. Tell us a little bit about yourself quickly.

Philip Oakley (00:38)
Thank you very much. Yeah, I'm Philip Oakley, owner and founder at Outserve. At Outserve we have a specialist team working with some fantastic ecommerce brands, helping them scale and grow, really understand their numbers and give them actionable data to make strategic decisions.

Elspeth From A2X (00:55)
Okay, so first of all in this video, let's just start with why cost flow matters so much for accurate cost of goods sold. What can happen if a brand uses the wrong method or, worse, mixes up their methods?

Philip Oakley (01:09)
Yeah, so I think we can get straight into it. I think we've got the slide with the different valuation methods, and I think at the top three, obviously, are average cost, LIFO — last in, first out — and FIFO — first in, first out. On this it's worth saying that for different countries and different accounting standards, LIFO isn't available for statutory compliance accounting in the UK under IFRS or UK GAAP, whereas it can be under US GAAP. So that would leave FIFO and average.

There are some key things to think about straight away between the different methods because it will actually change the profit that you're showing every month. We often see this where costs are rising or costs are falling. In the first in, first out methodology, if you were buying a product six months ago and that was costing you less than it is today, then you're actually going to charge your cost of goods sold account for a lower amount, so you will appear more profitable and actually show a higher value in stock. The opposite happens with last in, first out. So there are lots of things for businesses to consider even just in the profitability they will show with the different stock valuation methods.

Clearly some businesses might want to be tax efficient and may want to show a lower profit and be more up to date with higher costs when costs are rising. Other people may be looking for investment or even looking to sell the business and may want to show larger profit based on a consistent method. The most important thing is to be consistent. None of these stock valuation and cost methods are wrong for management accounts, but consistency is so important internally because you want to compare like for like. If you want to look at your profit today compared to this time last year, you need to use the same costing methodology — otherwise your comparison won't help you.

Elspeth From A2X (03:51)
Yeah, consistency is such a big thing in this area. What do you see if they've mixed up methods? If a brand or an online store has mixed up methods, what are the potential negative outcomes you've seen?

Philip Oakley (04:08)
I think they're giving themselves unclear or incorrect data to make decisions on. With price volatility and supply chain shocks, it can make a huge difference. We do a lot of business in food and beverage where price changes are obvious when you go to the supermarket — that can make such a difference to businesses in that sector. If you're a coffee roaster and the price of coffee increases significantly, and you're using an inconsistent method, you might look at today's figures and make decisions about how much you can spend on advertising, what channels to use, or what product to promote — and that data might not be up to date or correct. That won't help you make strategic decisions in the best interests of the business.

Elspeth From A2X (05:18)
Alright, before we get into how to choose the right method, could you give us a quick refresher on the three cost flow methods, Philip?

Philip Oakley (05:26)
Yeah, absolutely. Let's start with FIFO — first in, first out. It's common and makes sense, especially for food and beverage and businesses concerned about expiry or best-before dates. You want to get rid of the oldest stock first. As you take stock out, it's the oldest purchase price that comes out of stock. That will affect the profit and loss if prices are rising or falling, but FIFO often matches the reality of how businesses pick products. Your cost method should match how you actually pick products, and that's how we'd recommend most businesses operate.

Elspeth From A2X (06:34)
Makes sense. And the second one?

Philip Oakley (06:39)
The second is LIFO — last in, first out — which is essentially the opposite. It attributes the most recent purchase cost to COGS, so you're showing today's cost in your profitability. You can't think of many businesses that would physically pick that way, but for accounting it attributes the most up-to-date cost. LIFO isn't always accepted for statutory accounts in various countries under certain standards, but it can be used for management accounts and is permitted in the USA.

Elspeth From A2X (07:40)
Good clarifying point. What's the third one?

Philip Oakley (07:48)
The third is weighted average. This method is well supported by a lot of software. Weighted average looks at everything you've bought that's in stock, weights those purchases by quantity, and comes up with an average price. It smooths out spikes you might see with FIFO and LIFO and reduces price volatility across a management accounting period. It's popular, often easier to calculate, and widely supported by inventory management software. For many businesses it can be a fair and true reflection of profit depending on their products and trading style.

Elspeth From A2X (09:05)
Okay, Phil, could you walk us through the cost method decision chart — how you help a customer make this decision and the logic you use?

Philip Oakley (09:20)
Yeah, it's a useful decision tree. There's never a 100% hard rule, but it's a good start. Begin by asking: are your purchase prices stable month to month? If yes, weighted average will often be a good fit. If no, then consider accounting rules in your jurisdiction — for example, if you're under IFRS (UK businesses), LIFO isn't allowed, so your choices narrow to weighted average or FIFO.

If you're not under IFRS or you're in a region that allows LIFO, then consider tax goals. Is lowering taxable income a priority this year? If yes, LIFO could be attractive if allowed because it tends to reduce reported profit when costs are rising. If investors care about showing higher stock value and profitability, FIFO might be preferable. If none of those priorities dominate, weighted average is often the simplest and most supported option.

Elspeth From A2X (11:22)
That's super helpful, Phil — thanks for walking us through that. The key takeaway is to pick the method that matches your circumstances — price volatility, tax goals, and local reporting rules — then document it, apply it consistently, and lock it into all the systems you're using. If you'd like personalised advice, we recommend the Outserve team — they're experts. We've included a link in the description to talk to Phil and his team if you'd like. Phil, thanks again for being here today — this has been a really helpful insight into the thinking behind these decisions.

Philip Oakley (12:05)
Thank you very much. Thank you for having me.