How much have you spent on your current inventory? How much did you spend on inventory that you’ve already sold?
These are some of the most critical things retailers should be asking, and believe it or not, there is no one “right” answer to these questions, because of the various inventory costing methods out there.
What is Inventory Valuation?
Inventory costing or valuation is an accounting concept that has a direct impact on your gross profit and thus taxable income. Methods of valuing inventory are simply different cost-flow assumptions about how to allocate your cost of goods available for sale. They do not resemble your physical flow of goods, but rather, they allocate costs to either cost of goods sold or your ending inventory.
In this post, we’ll explore the different ways for valuing retail stock. Check them out below and see which one is right for your business.
First-in-first-out (FIFO) inventory valuation
According to the first-in-first-out (FIFO) inventory valuation method, it’s assumed that inventory items are sold in the order in which they’re manufactured or purchased. In other words, the oldest inventory items are sold first. The FIFO method is widely used because companies typically sell products in the order in which they’re purchased, so it best represents the actual flow of goods in a business.
FIFO method example:
Let’s say a business bought shirts on two separate occasions at two different prices during a month:
100 shirts at $10
200 shirts at $20
At the end of the month, the business had sold 50 shirts.
With FIFO, we use the costing from our first transaction when we purchased 100 shirts at $10 each.
So, after selling 50 shirts:
COGS = (50 shirts x $10 FIFO cost) = $500
50 shirts from the first purchase are still left on the shelves, costed at $10 each, as well as the remaining 200 shirts from the second purchase at $20 each. So:
Remaining inventory value = (50 shirts x $10 cost) + (200 shirts at $20 cost) = $4,500
Last-in-first-out (LIFO) inventory valuation
The last-in-first-out (LIFO) inventory valuation method assumes that the most recently purchased or manufactured items are sold first – so the exact opposite of the FIFO method. When the prices of goods increase, Cost of Goods Sold in the LIFO method is relatively higher and ending inventory balance is relatively lower.
LIFO method example:
Using the example above, the LIFO method would use the cost from the latest transaction when 200 shirts were purchased at $20 each.
After selling 50 shirts:
COGS = (50 shirts x $20 LIFO cost) = $1,000
The 100 shirts that we bought in the first purchase are still left at $10 each. We also have 150 shirts from the second purchase at $20 each. So:
Remaining inventory value = (100 shirts at $10 cost) + (150 shirts at $20 cost) = $4,000
Weighted average cost (WAC) inventory valuation
With the WAC inventory valuation method, inventory and COGS are based on the average cost of all items purchased during a period. This method is usually used when a business doesn’t have much variation in its inventory.
Weighted average cost example:
Based on the example above, you have 300 (100+200) shirts, which you paid $5,000 for in total ($100 x 10 + $200 x $20).
So, your weighted average cost would be the $5000 cost divided by the 300 shirts. This equals $16.67 per shirt.
After selling 50 shirts:
COGS = (50 shirts x $16.67 average cost) = $833.50
Remaining inventory value = (250 shirts remaining x 16.67 average cost) = $4,167.50
Which inventory valuation method is right for my business?
Choosing the right inventory valuation method for your business depends on a number of factors, like where your business is based, whether your costs are going up or down, and how much your inventory varies. When it comes to inventory accounting methods, most businesses use the FIFO method because it usually gives the most accurate picture of costs and profitability. But there’s no one-size-fits-all solution – so it’s best to speak to an accounting professional to find out what’s best for your business and situation.
Why not try it out for yourself? We, Offer a 14 Day Free Trial, so you can see just how much Goods Order Inventory can help your business. For more information and a tailored demonstration, please contact us or at firstname.lastname@example.org