Understanding the impact of inventory valuation methods—FIFO (First-In, First-Out), LIFO (Last-In, First-Out), and average cost—is crucial for analyzing financial statements. Each method influences the calculation of Cost of Goods Sold (COGS), which in turn affects gross profit, net income, and ending inventory values. Our solution also helps you implement the inventory costing method that best fits your business, providing real-time insights and ensuring that your inventory valuation is always accurate. This level of automation not only saves time but also helps you stay competitive and profitable in a fast-paced ecommerce environment. Inventory management software, such as Linnworks, can be invaluable in simplifying the inventory costing process. By automating the tracking of stock levels, sales, and inventory costs across multiple sales channels, Linnworks allows businesses to manage their inventory efficiently.

Financial Statement Effects of Inventory Costing Methods:Rising Prices

Higher prices drive higher business costs, making it increasingly tough to maintain profitability. But for most shareholders, investors, or senior executives, the data doesn’t matter — they’re still pushing their teams to achieve strong profit margins. FIFO is often preferred in industries where the costs of goods tend to increase over time.

As we’ve already seen, rising prices are putting pressure on operational costs, and that’s only set to continue into 2025. Increases in supply chain, raw materials, and recruitment costs aside, as inflation rises, employees demand higher salaries to maintain their quality of life. The perpetual inventory system offers real-time updates, keeping you constantly informed about your stock levels. On the other hand, the periodic inventory system involves periodic physical counts to determine inventory quantity and value. It’s important to note that businesses should consult with tax advisors or accountants to ensure compliance and make informed decisions regarding the most suitable method for them.

Bringing in more money and reducing expenses are the two core building blocks of driving profitability. In the world of ecommerce, managing your inventory is crucial to maintaining profitability. One key factor that can significantly impact your bottom line is how you calculate the cost of that inventory. Accurate time tracking is the key to profitability, enabling you to lift the lid on inefficiencies, resource optimization, and billing rates to improve your bottom line. In a world where costs are rising and competition is increasingly fierce, driving profitability is challenging for even the most talented CROs. Employee development is beneficial for morale and a great way to improve productivity.

Q: What are the different inventory costing methods?

The profitability of your business was previously based on squeezing your margin, but unfortunately, there’s no more fat left to squeeze, so raising prices will only make you less competitive. Since the COVID-19 pandemic, price increases have put immense pressure on businesses large and small. During this time, yearly inflation has ranged between 4% and 8%, labor costs continue to increase by around 4.5% per quarter, and some businesses have reported a 40% increase in supply costs. Common bundle models include BOGOF, buy-more-pay-less, or locking popular products into a determine which method will result in higher profitability when inventory costs are rising. ‘bundle-only’ sales model. Strike the right balance to ensure the bundle is perceived as a ‘better price’ by the customer and deliver that all-important increase in profitability. Once your team uses timesheets, our newly revamped Reports tab is where you can go to dive deeper into your labor costs, identifying trends and opportunities to improve productivity.

Financial Statement Effects of Inventory Costing Methods:Rising Prices Video Summary

This results in a Cost of Goods Sold (COGS) and ending inventory value that falls between those calculated using FIFO (First-In, First-Out) and LIFO (Last-In, First-Out). In a rising price environment, the average cost method will show COGS higher than FIFO but lower than LIFO, and ending inventory lower than FIFO but higher than LIFO. This method provides a middle-ground approach, reducing the extremes seen with FIFO and LIFO, and can be useful for companies with stable inventory costs.

What are the advantages of Specific Identification for inventory costing?

Conversely, LIFO (Last-In, First-Out) results in higher COGS because the newer, more expensive inventory is sold first. The ending inventory will be lower as it consists of the older, cheaper inventory. When examining ending inventory, FIFO will reflect a smaller balance, as it retains the less expensive, more recently acquired inventory. In contrast, LIFO will show a higher ending inventory value, as it leaves the older, more expensive items in stock. This relationship is essentially the opposite of what occurs in a rising price environment, where FIFO would yield lower COGS and higher profits, while LIFO would result in higher COGS and lower profits.

After we’ve analyzed why achieving profitability is so challenging in 2025, we’ll explore ways to redefine your profit strategy and improve your chances of business success. Additionally, companies that report using LIFO are required to disclose what their inventory values would be under FIFO, known as the LIFO reserve. This requirement enhances comparability between companies, allowing stakeholders to better understand the financial implications of different inventory accounting methods. Here’s how Talk Shop Media used our Toggl Track profitability report to improve the agency’s productivity. Many finance and budget management tools include complex algorithms to plan and predict the world ahead of you.

Alongside this, optimizing team structures by reviewing spans of control, hierarchical or matrix structures, or implementing a renewed RACI chart boosts efficiencies and drives productivity. As mentioned, hiring and onboarding costs drain company finances, and recruitment costs only increase in line with inflation. Let’s explore the leading profitability obstacles every business is facing in 2025 and why overcoming them requires intentional, out-of-the-box strategies. Compare this with an average net profit margin of 8.54% across all industries, and you’ll get a sense of what a ‘good’ profit margin looks like for you. If you’d like to find out how Linnworks can revolutionize your approach to inventory management, book a free demo today. Simple adjustments to your website can skyrocket your revenue and make big strides in your profitability with minimal effort.

Understanding the effects of inventory costing methods like FIFO, LIFO, and average cost on financial statements is crucial for accurate financial reporting and decision-making. These methods impact key financial metrics such as Cost of Goods Sold (COGS), gross profit, net income, and ending inventory. For instance, in a rising price environment, FIFO results in lower COGS and higher net income, while LIFO results in higher COGS and lower net income. These differences can affect a company’s tax liabilities, profitability analysis, and inventory valuation, making it essential for accountants and financial analysts to choose the appropriate method. Choosing between FIFO, LIFO, and average cost methods significantly impacts financial statements.

• This level of automation not only saves time but also helps you stay competitive and profitable in a fast-paced ecommerce environment.
• Every project should drive a clear benefit (ideally financial!) that nudges the business toward a high-profit position.
• James has 8 years’ experience leading projects and programs for tech, travel, digital, and financial services organizations, managing budgets in excess of £5m and teams of 30+.
• Insights into building businesses better, from hiring to profitability (and everything in between).
• The First-In, First-Out (FIFO) method assumes that the first items placed in inventory are the first to be sold.

Whether optimizing costs or finding ways to boost sales and revenue, several great tools on the market help CROs (and their colleagues) boost profitability. A clear strategy for when, where, and why you spend money is fundamental to driving profitability. While all businesses must evolve, not every project or initiative is essential, meaning sometimes it’s better to say no. As the cost of goods continues to rise, we predict the average profit margin will squeeze further, impacting financial performance. This will create an increased drive for operational efficiency and growth in new markets. Focusing on new and innovative profitability strategies is essential to achieving your business goals.

• Additionally, it provides a consistent basis for pricing decisions, which can be beneficial when inventory prices fluctuate frequently.
• Choosing the right inventory costing method involves considering industry norms, accounting regulations, and business objectives.
• From there, you can scale up to maximize the effectiveness and ROI of your technology investment.
• By automating the tracking of stock levels, sales, and inventory costs across multiple sales channels, Linnworks allows businesses to manage their inventory efficiently.
• On the other hand, the periodic inventory system involves periodic physical counts to determine inventory quantity and value.

The LIFO reserve is required to enhance comparability across companies that use different inventory costing methods. By disclosing the LIFO reserve, companies provide a clearer picture of their inventory valuation and financial position, allowing stakeholders to make more informed comparisons and decisions. Specific Identification is an inventory costing method where each item in inventory is tracked individually, with its specific cost assigned when it is sold. This method is typically used for high-value or unique items, such as luxury goods, automobiles, or custom-made products, where the exact cost of each item needs to be known. Unlike FIFO, LIFO, or WAC, Specific Identification requires precise tracking of each unit, making it a more labor-intensive method but necessary for businesses dealing with high-ticket items. The First-In, First-Out (FIFO) method assumes that the first items placed in inventory are the first to be sold.

This can result in higher profit margins since the revenue from sales is compared against lower-cost goods, improving overall profitability. One of the primary advantages of FIFO is its ability to provide accurate inventory tracking. Because you are selling the oldest items first, the cost of goods sold reflects the real price you paid for those items, which aligns better with current market prices. This method is especially beneficial for businesses that deal with perishable goods like food or fashion, as it reduces the risk of products becoming outdated or obsolete. Different costing methods can also impact how you report profits, affecting the timing of your tax liabilities. Choosing the right inventory costing method is a critical decision for ecommerce businesses.

Often, it’s about stripping things back to basics to uncover opportunities to reduce costs or drive additional revenue while being disciplined about the spending choices made across your businesses. Even with the right metrics, best customers, and high gross profit margins, increasing profitability is no easy task. This is because the global economic market is still so uncertain, with positive forecasts for growth (3.3% in 2025), offset by lingering inflation rates of 4.2%. FIFO can also result in lower taxable income during periods of rising prices, as older, lower-cost inventory is matched with current sales. For many ecommerce businesses, the best method is one that aligns with their pricing strategy, stock turnover rate, and tax planning objectives.

With the rise of artificial intelligence, these tools are becoming increasingly sophisticated. They predict risk events and issues before they occur and offer recommendations on how to optimize costs. It’s usually best to start small with automation so your business processes work as expected. From there, you can scale up to maximize the effectiveness and ROI of your technology investment.

Conversely, the Last-In, First-Out (LIFO) method sells the most recently acquired inventory first, which in a falling price environment means that the lower-cost items are recognized in COGS. This leads to a lower COGS, thereby increasing gross profit and net income, as expenses are minimized. While many businesses focus on simply cutting costs, you must also find ways to improve project profitability, maximize customer value, and deploy resources more effectively.

Inventory costing method FAQs

Linnworks helps thousands of ecommerce businesses worldwide to take control of their inventory, and to manage their ecommerce operations from a single, centralized HQ. James Elliott is an APMQ and MSP-certified project professional and writer from London. James has 8 years’ experience leading projects and programs for tech, travel, digital, and financial services organizations, managing budgets in excess of £5m and teams of 30+. James writes on various business and project management topics, with a focus on content that empowers readers to learn, take action, and improve their ways of working. Businesses are always looking for new and innovative ways to increase revenue with pricing strategies that grow the value per customer. If you’re a business owner, executive, finance professional, or Chief Revenue Officer (CRO) looking for new and innovative ways to boost profits, this is the article for you.