How you value inventory affects your cost of goods sold, your gross profit, and the accuracy of your financial statements. Here’s how the three most common inventory costing methods work, and how they differ.
Why inventory costing method matters
When you buy the same product at different prices over time, whether due to supplier price changes, bulk discounts, or market shifts, you need a consistent method to decide which cost applies when that stock is sold. This choice directly affects:
- Cost of goods sold (COGS): the cost assigned to inventory when it’s sold.
- Gross profit: revenue minus COGS, so your costing method directly shapes reported profit.
- Inventory valuation: the value of stock still on hand, shown on your balance sheet.
FIFO (First In, First Out)
FIFO assumes the oldest stock in your inventory is sold first. When you make a sale, the cost of your earliest, oldest purchase is used as the cost of goods sold, and the newest stock remains valued at its more recent price.
How it works in practice: if you bought 100 units at AED 10 last month and 100 more at AED 12 this month, and you sell 120 units, FIFO costs the first 100 units at AED 10 and the next 20 at AED 12.
FIFO is a widely used inventory costing method for retail and wholesale businesses, particularly where stock is physical, dated, or has a shelf life, since it naturally mirrors how older stock is typically sold or used first.
Average Cost (Weighted Average)
Average cost, also called weighted average cost, blends the cost of all available stock into a single running average cost per unit, recalculated automatically each time new stock is purchased at a different price.
How it works in practice: using the same example, if you bought 100 units at AED 10 and 100 more at AED 12, your average cost becomes AED 11 per unit ((100 × 10 + 100 × 12) ÷ 200). Every sale after that is costed at AED 11 per unit, until the next purchase changes the average again.
Average cost suits businesses with high transaction volume and mixed, non-perishable inventory, where tracking the cost of individual batches isn’t practical or necessary.
Last Purchase Cost
Last purchase cost uses the price paid on the most recent purchase as the costing basis for all inventory on hand, regardless of what earlier batches cost.
How it works in practice: if your last purchase was 100 units at AED 12, all inventory of that item is valued at AED 12 per unit going forward, until the next purchase changes it again.
This method is useful when replacement costs change frequently and a business wants its inventory valuation to reflect current market pricing rather than historical averages.
Comparing the three methods
| Method | Costs stock based on | Best suited for |
|---|---|---|
| FIFO | Oldest purchase price first | Physical, dated or perishable stock |
| Average Cost | A blended average of all stock | High-volume, mixed non-perishable inventory |
| Last Purchase Cost | Most recent purchase price | Frequently changing replacement costs |
None of these methods is universally “correct”. The right choice depends on how your inventory actually moves and how you want your financial reporting to reflect cost changes over time.
How MySale App and MySaleBooks support this
MySale App and MySaleBooks include all three inventory costing methods, FIFO, Average Cost (weighted average) and Last Purchase Cost, on every plan, with inventory valuation calculated in real time as stock moves. See the full feature comparison or explore Features for more detail. If you’re not sure which costing method fits your business, get in touch and our team can help you decide.