FIFO, LIFO or Average Cost — Which Inventory Valuation Method is Best for Makers?

Choosing the right inventory valuation method has real consequences for your handmade business: it affects how you report COGS, what you owe at tax time, and whether your product pricing actually reflects your true costs.

The three methods you’ll encounter most often are FIFO (First-In-First-Out), LIFO (Last-In-First-Out), and the Rolling Weighted Average. Each works differently, and each suits different business situations.

This guide explains how each method works, shows maker-specific examples, and helps you decide which one to use.

What is an inventory valuation method?

An inventory valuation method is a system used to assign costs to the materials and products held in inventory. It determines how much each unit of inventory is worth, which directly affects your cost of goods sold, your gross profit, and your tax obligations.

There are multiple methods for calculating inventory valuation, with FIFO, LIFO, and the Rolling Weighted Average being the most commonly used. Each method produces different financial results from the same underlying inventory — so the choice matters.

FIFO (First-In-First-Out)

FIFO means you always use and cost the oldest stock in your inventory first. The first materials you purchased are the first ones counted as “used” when you make a sale.

Think of a supermarket shelf: the employee adds new products to the back, and customers take from the front. Stock continuously moves forward until it leaves the shelf.

A candle-making example: You buy 10kg of soy wax in January for $5/kg, then another 10kg in March for $6/kg. Under FIFO, when you make and sell a candle in April, you cost it using the $5/kg January wax first — even if the March batch is physically what you grabbed off the shelf.

This works well if you genuinely rotate stock (older materials get used first), but it can mismatch your costs and revenue when there’s a long gap between buying materials and using them.

Pros and Cons of FIFO

Pros:

• Mirrors the physical flow of goods for most businesses
• Reduces obsolescence risk — older items are costed first
• Reliable in stable markets where prices don’t fluctuate much

Cons:

• In periods of inflation, FIFO reports higher net income (older, cheaper costs matched against current revenue) — which means a higher tax bill
• Can create a cost/revenue mismatch if there’s a long lag between purchase and production
• More admin overhead if you’re manually tracking which batch you used

LIFO (Last-In-First-Out)

LIFO means you cost the most recently purchased materials first. Your newest stock is the first one counted as “used.”

Using the supermarket analogy: the employee now adds new items to the front of the shelf, and customers also take from the front — meaning the oldest stock never leaves.

A soap-making example: You buy 5kg of shea butter in January for $20/kg, then 5kg more in June for $25/kg. Under LIFO, when you make soap in July, you cost the shea butter at the June price ($25/kg) — even though the January batch is still sitting on your shelf.

LIFO can lower your taxable income during inflation (higher recent costs = higher COGS = lower profit). However, it’s banned under international financial reporting standards (IFRS) and is only permitted under US IRS regulations in specific circumstances. Businesses operating outside the US or planning to expand internationally cannot use LIFO.

Pros and Cons of LIFO

Pros:

• Reflects current costs in your COGS, matching today’s market conditions
• Can reduce taxable income during inflationary periods
• Useful when material prices are consistently rising

Cons:

• Doesn’t match the physical flow of goods — older inventory accumulates
• Higher risk of obsolete stock sitting unused
• Reported inventory value is often lower than actual current market value
• Not accepted under IFRS — can’t be used if you operate or report internationally

The Rolling Weighted Average Method

The rolling weighted average method is most commonly used in manufacturing situations where materials are mixed or stored together and can’t be separated by individual purchase batch. It’s the method used by most inventory management software — including Craftybase.

In 2008, the IRS confirmed that using rolling average costs is an allowable method for calculating inventory under US tax rules.

How it works: Every time you add stock, the system recalculates the average cost per unit across all stock on hand. Every time you use stock, it uses that current average as the cost.

A candle-making example: You have 10kg of soy wax at $5/kg (total: $50). You buy another 5kg at $6/kg (total: $30). Your new rolling average cost becomes $80 ÷ 15kg = $5.33/kg. The next candle you make is costed at $5.33/kg for the wax it uses.

This method requires a perpetual inventory system — one that tracks every purchase and every usage as it happens. If you’re using a paper-based periodic system (counting inventory once a year), weighted average won’t work for you.

More details on how rolling averages are calculated: What is the Weighted Average Cost Method?

Pros and Cons of the Rolling Weighted Average Method

Pros:

• Provides a smooth, accurate cost per unit that blends all purchase prices
• Less sensitive to short-term price spikes — one expensive batch won’t blow out your COGS
• Widely accepted under both US (IRS) and international (IFRS) standards
• Well-suited to automation — software like Craftybase handles all the recalculations

Cons:

• Requires a perpetual inventory system — periodic/manual systems can’t use it accurately
• More complex to calculate manually (though software eliminates this problem)
• When costs fluctuate significantly, the average may lag behind current prices

Which inventory method should you choose?

Here’s a practical guide for handmade sellers:

Use the Rolling Weighted Average if:

• Your materials are mixed together (e.g., bulk soy wax, resin, soap base)
• You use inventory management software that tracks purchases and usage in real time
• You want a method that works under both US and international standards

This is the most common choice for small makers, and it’s what Craftybase uses automatically.

Use FIFO if:

• You sell a low volume of products and cost each one individually
• Your materials have a meaningful shelf life and you genuinely use oldest stock first
• You can maintain a spreadsheet or record of which batch was used for each order

Use LIFO only if:

• You’re US-based (LIFO is banned internationally)
• You’re experiencing significant material price inflation and want to reduce taxable income
• You’ve spoken to an accountant about whether it’s appropriate for your situation

Whatever method you choose, it should be applied consistently — the IRS expects you to use the same method year over year unless you formally apply to change.

Using software to calculate inventory valuations

Software handles the complex recalculations involved in inventory valuation — especially for the rolling weighted average method.

Craftybase is inventory management software built specifically for small manufacturers and handmade sellers. It uses the rolling weighted average method to automatically track your material costs and calculate your COGS in real time as you buy, manufacture, and sell.

Every time you record a material purchase, Craftybase recalculates the average cost per unit. Every time you manufacture a product, it uses those current costs to calculate your production cost automatically — no spreadsheets, no manual maths.

This means at tax time, your COGS figures are ready to go. You’re not scrambling to reconstruct what you paid for materials six months ago.

Frequently Asked Questions

Conclusion

The goal of inventory valuation is to accurately determine your cost of goods sold and the value of the stock you have on hand — both of which flow directly into your financial reports and tax return.

For most handmade sellers, the rolling weighted average method is the right choice. It handles fluctuating material costs gracefully, it’s accepted by the IRS and under international standards, and it’s the foundation of how Craftybase tracks your inventory automatically.

If you’ve been calculating your COGS by hand or using a spreadsheet, Craftybase can take over that process entirely — keeping a running average cost for every material you buy, and automatically calculating your production cost every time you manufacture.

We recommend speaking with a qualified accountant to confirm the best inventory valuation method for your specific business situation, especially at tax time.