The three methods in one paragraph each.
FIFO (first in, first out) assumes the oldest inventory is sold first. The cost of the earliest units flows to COGS; the most recent units stay on the balance sheet. In rising-price periods, FIFO produces lower COGS, higher gross profit, and higher inventory value. LIFO (last in, first out) is the opposite: most recent units flow to COGS first; older units stay on the balance sheet. In rising-price periods, LIFO produces higher COGS, lower gross profit, and lower inventory value.
Weighted average computes one average cost per SKU and applies it to every sale and every inventory balance. Each new purchase updates the weighted average. The result sits between FIFO and LIFO. Weighted average is the easiest to compute, the most stable through price swings, and the method most software products use as the default. The differences become significant only when inventory turns slowly or prices move sharply.
Worked example: a New York wine shop.
A wine shop buys 100 bottles of a Bordeaux: 40 in January at USD 30 each, 30 in February at USD 35, 30 in March at USD 40. Total inventory cost: 1,200 + 1,050 + 1,200 = USD 3,450. In April, the shop sells 60 bottles at USD 65 retail. Revenue 60 * 65 = USD 3,900.
FIFO COGS: 40 * 30 + 20 * 35 = 1,200 + 700 = USD 1,900. Gross profit 3,900 - 1,900 = USD 2,000. Margin 51 percent. Remaining inventory: 10 * 35 + 30 * 40 = USD 1,550. LIFO COGS: 30 * 40 + 30 * 35 = 1,200 + 1,050 = USD 2,250. Gross profit 3,900 - 2,250 = USD 1,650. Margin 42 percent. Remaining inventory: 40 * 30 = USD 1,200. Weighted average cost = 3,450 / 100 = USD 34.50. COGS: 60 * 34.50 = USD 2,070. Gross profit 1,830. Margin 47 percent. Remaining inventory 40 * 34.50 = USD 1,380.
What each method does to your taxes.
Higher COGS means lower taxable income. In rising-price periods, LIFO minimizes tax (highest COGS), FIFO maximizes tax (lowest COGS), and weighted average sits between. Over the long run, the same total profit is taxed; the difference is timing. LIFO defers tax to future periods. The US allows LIFO under GAAP and the IRS, with the LIFO Reserve disclosure. UK, Australia, India, and Pakistan generally prohibit LIFO under IFRS. So your jurisdiction effectively decides whether LIFO is even on the table.
For most non-US businesses, the real choice is FIFO vs weighted average. Weighted average is simpler and produces more stable margins. FIFO matches better against the physical reality (you do typically sell the oldest stock first for perishables). The tax impact in a stable price environment is negligible. In a high-inflation environment (Pakistan 2026, with PKR weakening 12 percent year over year), FIFO inflates margins on paper and the tax bill follows.
When FIFO is the right choice.
FIFO is the natural fit for perishables, fashion, electronics, and any inventory where physical first-in-first-out is enforced by spoilage, obsolescence, or fashion cycles. A pharmacy literally must sell the oldest batch first or pay a regulator fine for expired stock. A clothing retailer marks down old-season inventory because it cannot sell at full price. FIFO matches the physical flow and produces a clean audit trail.
FIFO also produces a more realistic balance sheet because inventory is valued at recent costs (the most recent purchases sit on the balance sheet). In a rising-price economy, this means the inventory value is closer to replacement cost. For lenders who use inventory as collateral, FIFO inventory is easier to assess. The downside is that FIFO requires lot tracking. The software must remember which units came from which purchase order, at which cost.
When weighted average wins.
Weighted average is the right choice for commodity inventory (steel, rice, sugar, chemicals) where individual units are indistinguishable and lot tracking is unnecessary. A Karachi rice trader buying 50,000 kg of basmati at PKR 280 per kg and another 30,000 kg at PKR 295 per kg does not care which bag came from which lot. Weighted average cost = (50000 * 280 + 30000 * 295) / 80000 = PKR 285.62 per kg. Every sale and every balance uses that number until the next purchase changes it.
Weighted average also wins when price volatility is high. FIFO under volatility produces wild margin swings as old cheap inventory flushes out and new expensive inventory hits the books. Weighted average smooths these. For a Lahore steel trader navigating 30 percent year-on-year price moves, weighted average gives a stable monthly P&L the bank actually trusts. Nonari uses weighted average per SKU per branch as the default for exactly this reason.
- FIFO: perishables, fashion, electronics, lot-tracked goods.
- Weighted average: commodities, high-volatility prices, multi-branch.
- LIFO: US-only, high-inflation, tax-driven choice with disclosure.
- Specific identification: serialized inventory (cars, equipment).
Switching methods: when and how.
Once you pick a method, apply it consistently. Switching mid-year is forbidden by every accounting standard and tax authority because it creates an artificial profit or loss in the switch period. You can change methods at the start of a new fiscal year with disclosure, regulator approval (where required), and a restatement of prior period inventory for comparability. The IRS requires Form 3115 for any inventory method change.
In practice, most businesses pick a method on Day 1 and never switch. The exception is when a business merges with another using a different method. Then the resulting entity standardizes (usually on the larger entity method) and the smaller entity inventory is revalued at the start of the new period. This is one of the unglamorous but expensive parts of M&A integration that nobody tells you about until the auditor asks for the revaluation memo.
What software does and does not automate.
Modern accounting and inventory software handles weighted average and FIFO out of the box. Every receipt updates the cost ledger, every sale relieves inventory at the chosen method, the COGS journal entry posts automatically, and the inventory value on the balance sheet stays current. LIFO requires more specialized software and is less commonly supported outside US-focused products.
What software does not automate: the policy decision. The owner or CFO picks the method. The software enforces it. If you set up Nonari on weighted average and then ask for FIFO-style reports after a year, you cannot retroactively switch without restatement. Pick at setup, document the choice in your accounting policy, and let the software run consistently. The audit trail then defends the books indefinitely.