All three methods answer the same question: when you sell something from inventory, what cost do you assign to the items that left? Since you typically buy the same product at different prices over time, you need a consistent rule for figuring out which cost hits your profit and loss statement when a sale happens.

FIFO stands for First In, First Out. It assumes the oldest items you purchased are the ones you sell first. Say you bought 100 widgets at $5 each in January and another 100 at $7 each in March. If you sell 100 widgets in April, FIFO says you sold the $5 batch. Your cost of goods sold is $500, and the inventory still on your shelves is valued at $700.

LIFO stands for Last In, First Out. It flips the assumption. Using that same example, LIFO says the April sale pulled from the $7 batch. Your cost of goods sold is $700, and remaining inventory is valued at $500. Same physical goods, same sale, but different numbers on your financial statements.

Weighted average takes a blended approach. Instead of tracking batches, you average the cost of everything in stock. With 200 widgets at a combined cost of $1,200, your average cost per unit is $6. Sell 100 and your cost of goods sold is $600, with $600 left in inventory.

The reason this matters is that each method changes your reported profit and your tax liability. When prices are going up (which they usually are), FIFO produces higher profit because you’re matching older, cheaper costs against current revenue. LIFO produces lower profit because you’re matching newer, more expensive costs against that same revenue. Lower reported profit means a lower tax bill, which is why some businesses prefer LIFO. Weighted average falls somewhere in between.

A few practical things to know. FIFO is by far the most common method for small businesses and the default in QuickBooks Online. It’s straightforward, easy to understand, and produces a balance sheet inventory value that closely reflects what your stock is actually worth today. LIFO is allowed for US tax purposes but adds complexity and is rarely worth it for smaller operations. Weighted average works well for businesses selling large volumes of interchangeable products where tracking individual batches is not realistic.

Once you choose a method, the IRS expects you to stick with it consistently. Switching requires filing a formal request with the IRS, and they want a valid business reason. So pick the right method upfront rather than trying to change it later.

If you carry significant inventory and are not sure which method makes sense, it is worth talking through the decision with a QuickBooks ProAdvisor in Chandler who understands how the choice flows through to your financial statements and your tax return. The right method depends on your product type, how much your costs fluctuate, and whether minimizing taxes or showing accurate margins matters more to your business. Proper inventory accounting from the start saves you from having to untangle the wrong method later.