FIFO vs Average Costing: What It Does to Your Profit
Two identical stores can report different profits just by valuing inventory differently. FIFO vs weighted average, the impact on COGS, and how to choose.
Here is a party trick for accountants: two shops with identical sales, identical stock, identical prices can legally report different profits. No fraud involved. They simply answer one innocent question differently: “the unit we just sold — what did we pay for it?”
The question sounds trivial until purchase prices start moving. And purchase prices always move.
One product, several purchase prices
Say your store buys cooking oil three times this month. Early in the month, 100 cartons at 180 (thousand rupiah, but the currency does not matter). Mid-month, 100 more at 190. End of month, 100 at 200. Now one carton sells for 220. What was its cost?
“Depends which carton” is not an answer bookkeeping can use — physically the cartons are identical and mixed together in the stockroom. Accounting needs a consistent rule. The two rules small businesses actually use:
FIFO (first in, first out) assumes the units sold are the oldest ones. The first cartons out the door carry a cost of 180, and only after the first hundred are “used up” on paper does the cost step up to 190.
Weighted average blends every purchase into one number. Total spend on 300 cartons was 57,000, so each carton costs 190 — and that figure applies to every sale until the next purchase shifts the average.
The difference is not pocket change
Continue the example: 150 cartons sold this month at 220 each, revenue 33,000.
Under FIFO, cost of goods sold = 100 x 180 + 50 x 190 = 27,500. Gross profit 5,500.
Under average, COGS = 150 x 190 = 28,500. Gross profit 4,500.
Same transactions, a 20% swing in reported gross profit. The pattern is reliable: while purchase prices are rising, FIFO produces lower COGS and fatter paper profit, because the cheap old stock gets “sold” first. Average is calmer — price spikes get smeared out, and profit stops jumping around.
That fatter FIFO profit is pleasant to look at, but it hides a trap: your next restock must be paid at the new, higher prices. If FIFO profit becomes the basis for owner drawings or profit sharing, the working capital for the next purchase quietly erodes. Seasoned traders know this by instinct without knowing the term: profit is not really profit while your replacement cost is climbing.
Which one fits your business
There is no universal answer, but there are anchors.
Average suits bulk goods and commodities that genuinely mix together — rice, oil, building materials, kitchen ingredients. The math stays calm, the P and L stays readable, and it is easy to explain to anyone.
FIFO suits you if you want the inventory value on the balance sheet to track current market prices, or if your goods physically do leave in order of arrival. For anything with an expiry date, FIFO’s sibling — FEFO, first expired first out — deserves a serious look; we cover it in managing expiry-dated stock with FEFO.
More important than the choice itself: consistency. Switching methods every year makes periods impossible to compare, and tax authorities generally expect you to stick with one method. Indonesian tax rules, for instance, only recognize FIFO and average for inventory — LIFO is off the table, which mercifully removes a third option to agonize over.
This is the software’s job, not yours
The good news: in 2026 nobody should compute this by hand. Maintaining a rolling average in a spreadsheet across hundreds of SKUs and dozens of monthly purchases is a formula error waiting to happen. Any decent POS or inventory system calculates COGS automatically on every transaction, using the method you picked once during setup.
In Tenavora, the costing method (FIFO, FEFO, average, or standard) is chosen per item, and COGS plus inventory value flow straight into the profit and loss statement and balance sheet — no month-end recalculation. If your books still treat every unit as if it cost the same, read automated bookkeeping for small business next.
One practical step for this week: pull the purchase history of your best seller for the last three months. If the buy price moved more than a few percent, compute profit both ways, once. That single number usually cures anyone of the idea that inventory valuation is just accountant trivia.