Inventory Valuation Methods for Stock Management

Inventory Valuation is defined as the cost of a business’s inventory at the end of the financial year or reporting period. It is an accounting practise to help you calculate the value of goods sold throughout the year as well as unsold inventory.

What are the different types of Inventory Valuation Methods?

There are numerous Inventory Valuation methods used in stock management, and they all have different benefits and drawbacks for your business.

Below is a list of all 4 of the main inventory valuation methods:

• First In First Out (FIFO)
• Last In First Out (LIFO)
• Weighted Average Cost
• Specific Identification

Before you can begin counting it is important to have your stock well organised to make the valuation quicker and more accurate. Check out our 5 top tips for organising stock in e-commerce businesses.

First In First Out (FIFO) assumes the products or stock purchased first will also be the first to be sold and leave the warehouse. FIFO allows you to assign a specific value to each item which gives a more accurate view of the value of inventory. FIFO can also be used to give a better understanding of the profit margins of a business.

For example, if you bought 3 identical phone cases at the following prices (increasing manufacturer or supplier costs):

• 10 at £8 in January
• 10 at £9 in February
• 10 at £10 in March

Each time you sold an item, you would deduct it from the oldest item on the list; so the £8 item would be accounted for first even if the case which cost £10 was actually sold first.

In this example, if you sold 20 of the phone cases and had 10 left over then you would use the March price to calculate the value of the leftover inventory.

10 x £10 = £100

Your leftover stock would therefore be worth £100. If you had leftover stock that was bought at two or more different prices, then you would do separate calculations to value the stock at the price it was bought at and add it all together.

When should I use the FIFO valuation method?

FIFO is an extremely simple and therefore universal valuation method which can be used for almost any type of inventory. This makes it popular with e-commerce companies as it’s straightforward and can easily be calculated.

The FIFO valuation method is also useful for products with a shorter or time sensitive shelf life such as cosmetics or food.

As you might’ve already established, LIFO is the opposite of FIFO because it involves accounting for stock by assuming the last items to enter the warehouse or storage facility were the most recently sold items.

Using the same example as the FIFO Method:

• 10 at £8 in January
• 10 at £9 in February
• 10 at £10 in March

If you sold 20 of the phone cases  and had 10 left over; then you would use the January price to calculate the inventory value.

10 x £8 = £80

Your leftover stock would therefore be worth £80 which is £20 less than the FIFO valuation method. This shows how different valuation methods can produce very different results.

When should I use the LIFO Valuation Method

LIFO isn’t actually widely used as it’s seen as a less realistic and accurate valuation method compared to FIFO. It is used by more frequently during periods of inflation and it does have more accurate profit calculations but for the past, FIFO is the more suitable option between the two.

Weighted Average Cost calculates the average cost of goods over a period of time. The other inventory valuation methods covered so far calculate the cost of goods sold (COGS). Weighted Average Cost requires you to calculate the cost of goods sold and then calculate an average of what can be used for unsold goods.

Using the phone case example we used above:

• 10 at £8 in January
• 10 at £9 in February
• 10 at £10 in March

(10 x 8) + (10 x 9) + (10 x 10) = £270

£270/30 = 9

Total cost of goods sold for 20 phone cases = £180

Value of leftover goods = 10 x 9 = £90

When should I use Weighted Average Cost Valuation Method?

Weighted Average is Cost is only really useful when the goods you sell are all very similar and there isn’t much variation in price. Therefore, goods that might have different stock management codes might have the same price which makes it easier to find an average for the whole range of products.

The specific identification method is used for keeping track of exact cost of each item in your inventory. This method is therefore useful for businesses where each item is unique and can be easily identified or tracked. An example of this could be fine art or furniture or any business which has very low inventory with varying prices.

The formula for calculating specific identification is very simple because it requires a lot of details of the inventory.

Simple Identification = Value of unsold items – Cost of Goods

When Should I use the Specific Identification Method?

As mentioned earlier, specific identification requires detailed tracking of individual products, so it isn’t useful for a lot of businesses and is only useful for jewellery, vehicles, art and similar businesses.

For these reasons, Simple Identification is useful for businesses that need to accurately track inventory. Specific identification is also really useful for businesses that want to advanced tracking of inventory using digital programs and databases.

Working with a trusted logistics provider can help simplify your stock management needs. When you are storing your stock at a third-party warehouse it can be challenging to get an accurate picture of what you have and how much capital you have tied up in your stock.

At Allegro logistics we have transparent and real-time reporting to allow business owners to get an accurate view of their stock levels.

Learn more about our e-commerce fulfilment services with real-time reporting >

E-Commerce Fulfilment Services with Allegro Logistics

As experts in order fulfilment and stock management, you can rely on us to take care of your all third-party logistics needs.

With our seamless e-commerce software integration, you can benefit from improved management efficiencies. Our platform even comes with a dedicated inventory management tool which you can use to accurately monitor your inventory levels and calculate your inventory valuation.

Get in touch today to find out how we can help you.