What is Inventory Valuation?

Inventory valuation is the accounting practice of assigning a monetary value to all unsold goods in a business’s inventory at the end of a reporting period. The valuation method chosen determines how the cost of goods sold (COGS) is calculated on the income statement and how inventory is reported as an asset on the balance sheet. Since inventory is typically one of the largest assets for product-based businesses, the valuation method has a significant impact on reported profitability, tax liability, and financial ratios that lenders and investors scrutinize. The three primary inventory valuation methods are FIFO (First In, First Out), LIFO (Last In, First Out), and Weighted Average Cost.

Why It Matters

Inventory valuation is not just an accounting exercise—it directly affects how much profit a business reports and how much tax it pays. The same physical inventory can produce different profit figures depending on which valuation method is used, because each method assigns costs to sold and unsold goods differently. In periods of rising costs (inflation), FIFO produces lower COGS and higher reported profits (because older, cheaper costs are matched to revenue), while LIFO produces higher COGS and lower reported profits (because newer, more expensive costs are matched to revenue).

For e-commerce businesses, accurate inventory valuation is also essential for understanding true product profitability. If inventory costs aren’t tracked and valued correctly, gross margin calculations become unreliable—making it impossible to know which products are truly profitable and which are losing money after accounting for all costs. This insight drives critical decisions about pricing, promotions, product assortment, and supplier negotiations.

How It Works

The three main inventory valuation methods differ in how they assign costs:

• FIFO (First In, First Out): Assumes that the oldest inventory (first purchased) is sold first. COGS reflects the cost of the earliest-purchased units, while ending inventory reflects the cost of the most recently purchased units. FIFO typically provides the most accurate balance sheet valuation because ending inventory values are based on recent, current-market costs. It is the most widely used method in e-commerce and retail.
• LIFO (Last In, First Out): Assumes that the newest inventory (last purchased) is sold first. COGS reflects the cost of the most recently purchased units, producing higher COGS during inflationary periods and lower taxable income. LIFO is permitted under U.S. GAAP but prohibited under IFRS (International Financial Reporting Standards), making it unavailable for businesses reporting under international standards.
• Weighted Average Cost: Calculates a single average cost per unit by dividing total cost of goods available for sale by total units available. This average cost is applied to both COGS and ending inventory. The weighted average method smooths out price fluctuations and is simpler to compute than FIFO or LIFO, making it practical for businesses with large quantities of similar, interchangeable products.
• Specific Identification: Tracks the actual cost of each individual unit. Used for high-value, unique, or serialized items (vehicles, jewelry, art) where each unit has a meaningfully different cost. Impractical for high-volume commodity goods.
• Consistency and Compliance: Once a valuation method is chosen, accounting standards require consistent application across periods. Changing methods requires disclosure and potentially restating prior period financial statements. Businesses should select the method that best reflects their cost flow and maintain it consistently.

How Nventory Helps

Nventory tracks inventory costs at the SKU level, recording the cost of each purchase order and receiving event. This cost data feeds into COGS calculations and inventory valuation reports that align with your chosen accounting method. When integrated with your ERP or accounting system, Nventory ensures that inventory values on the balance sheet accurately reflect the cost of goods on hand—eliminating the manual cost tracking and spreadsheet reconciliation that leads to financial reporting errors.