Retail Costing, FIFO, LIFO, Average COST?

Retailers need to control their costs with an iron fist, since cost of inventory is often one of, if not the, largest cost of doing business.  It is also one of the things that a retailer can control by working with vendors, as opposed to rent and utilities, which are essentially fixed costs.

There are various methods for calculating inventory cost, but the most common are "First In First Out" or FIFO, "Last In First Out" or LIFO, and Average Cost.

To determine which one is appropriate for your business you need to understand the following things:

-Frequency of price changes from your vendors

-Granularity of data, can you track cost by individual item unit?

-Ability of the POS system to handle serial numbers and other identifiers

-Cost of the effort involved in tracking costs by item.

In reality FIFO and LIFO are similar, and typically apply to items that can be tracked by serial number or other unique identifier.  If you receive 20 items a week, and they are identical outside of a mid-week cost change, it may be impractical or impossible to use FIFO and LIFO.

For this reason, most retailers use Average Costing.    This works because over time any changes in cost versus retail price even out due to the total volume of sales. 

Stated another way, it's not important to know the cost of "this particular widget" as long as you know that you sold 20 widgets and the average cost was "$X.XX"  Once the cost increases beyond a certain threshold, you need to increase your retail price to protect your margins.

Average costing is also the easiest to maintain and can be handled on the fly, saving you time and effort in tracking your inventory, while still giving you good data.

FIFO and LIFO certainly have their places, but for the average small retailer, Average Cost is a time saver that is easily managed with a good POS.