Inventory Valuation Methods: FIFO, LIFO, and Weighted Average Explained

Why inventory valuation method matters#

When you sell a product that you have purchased in multiple batches at different prices — say £8 in January, £9 in April, and £10.50 in July — which cost do you record as cost of goods sold? The answer determines your reported gross margin and the value of remaining inventory on your balance sheet. In a period of rising costs (common for importers dealing with supplier price increases and currency depreciation), the choice between FIFO and weighted average produces meaningfully different profit numbers.

FIFO: First In, First Out#

FIFO assumes that the oldest stock is sold first. In a period of rising costs, FIFO expenses the lower (older) costs first — resulting in higher reported gross margin and higher remaining inventory value on the balance sheet (because the newer, higher-cost stock is still sitting there). FIFO is the most logical method for businesses that genuinely sell oldest stock first — grocery, food, and any perishable or date-sensitive product. It is also the most commonly used method in the UK. In a period of rising costs, FIFO produces higher reported profits.

Weighted Average Cost#

The weighted average method blends all stock costs together into a single average cost per unit. When new stock arrives at a different price, the average is recalculated. Each unit sold is then valued at the current weighted average cost, regardless of when it was purchased. In a period of rising costs, the weighted average produces a cost per unit between the oldest (lower) and newest (higher) costs — resulting in a gross margin between the FIFO and LIFO results. Weighted average is simpler to administer and smooths cost fluctuations, making it popular for businesses with frequent small deliveries at varying prices.

LIFO: Last In, First Out#

LIFO assumes the newest stock is sold first — expensing the most recent (often higher) costs while leaving older (often lower) costs on the balance sheet. In a period of rising costs, LIFO produces lower reported gross margin and lower reported profits than FIFO. LIFO is not permitted under IFRS (International Financial Reporting Standards) or UK GAAP — it is only used in the United States under US GAAP for tax deferral purposes. If you are a UK business, you cannot use LIFO for financial reporting purposes.

Which method to choose and why it matters for decisions#

UK businesses should use either FIFO or weighted average cost. FIFO is appropriate where goods are physically sold oldest first (food, perishables, fashion). Weighted average is appropriate where goods are interchangeable and physically indistinguishable regardless of purchase date (most manufactured goods, raw materials). The choice affects not just reported profit but also your product pricing decisions — if you use FIFO and have a large batch of old, lower-cost stock, your current gross margin calculation may show a higher margin than your next replenishment batch will sustain. Knowing your true forward-looking cost (the cost of your most recent stock) is as important as knowing your accounting cost of goods sold.