FIFO vs Weighted Average Inventory Valuation: Which Fits You?

When you buy the same item at different prices over time, one question decides everything: at what cost do you record the units you sold? The answer drives two sensitive numbers: cost of goods sold (COGS) and the value of the inventory left on your balance sheet.

Since profit = revenue − cost of goods sold, the valuation method you pick changes your reported profit, even when your actual sales and purchases have not moved at all.

The two most widely used methods in Saudi Arabia are first in, first out (FIFO) and weighted average cost. Last in, first out (LIFO) is not permitted under the adopted international standards, so it is not used.

The principle: the units you bought first are the ones treated as sold first for accounting purposes. Cost of goods sold is taken from the oldest batches, and the remaining inventory stays valued at the most recent prices.

The practical logic: it mirrors the natural flow of most goods, especially perishables such as food, medicine and cosmetics, where the oldest stock physically goes out first to avoid expiry.

The effect when prices are rising (inflation):

• Cost of goods sold is lower, because it comes from older, cheaper prices.

• Reported profit is higher.

• Inventory on the balance sheet is valued at the latest prices, closer to current value.

The other side of that coin: a higher profit means a higher apparent tax and Zakat burden.

The principle: each unit sold is costed at the average cost of all available units, weighted by their quantities.

The formula:

Average cost per unit = total cost of goods available ÷ total number of units available

The practical logic: it smooths out swings in purchase prices, so a price jump on a single batch does not move your profit. It fits homogeneous goods whose batches are hard to track individually, such as raw materials, liquids, screws and grains.

Two variants:

• Periodic weighted average: calculated once at the end of the period.

• Moving weighted average: recalculated after every new purchase, which is what modern accounting systems do in real time.

A shop buys item X in three batches during one month:

It then sells 200 units during the month.

Under FIFO (the oldest units are sold first):

• Cost of goods sold = (100 × 10) + (100 × 12) = SAR 2,200

• Remaining inventory (100 units at the latest price) = 100 × 14 = SAR 1,400

Under the weighted average method:

• Average cost = 3,600 ÷ 300 = SAR 12 per unit

• Cost of goods sold = 200 × 12 = SAR 2,400

• Remaining inventory = 100 × 12 = SAR 1,200

The takeaway: identical purchases and identical sales, yet cost of goods sold differs by SAR 200 (2,200 against 2,400). Profit and inventory value differ with it.

Take the example above and assume a selling price of SAR 20 per unit (revenue of 200 × 20 = 4,000):

When prices are rising, FIFO shows a higher profit and a higher inventory value, while the weighted average gives a more conservative picture.

The Zakat effect: inventory is a current asset and enters the Zakat base at its book value. The valuation method therefore moves both the inventory figure in the base and the profit. What matters, under Shariah and under the regulations alike, is consistency of method. Switching between methods year after year to flatter the results is not acceptable; any change needs a genuine justification and must be disclosed.

Choose FIFO if:

• Your goods are perishable or carry an expiry date, such as food, medicine and cosmetics.

• You want the inventory figure on the balance sheet to sit close to current market value.

• Tracking batches individually is realistic in your business.

Choose the weighted average if:

• Your goods are homogeneous and batches are hard to tell apart, such as raw materials, liquids and identical parts.

• You want to smooth the effect of purchase price swings on your profit.

• Transaction volume is high and tracking every batch separately is impractical.

The golden rule: pick the method that reflects how your business actually works, then stay with it. Consistency matters more than finding the perfect method.

Applying a valuation method depends on your inventory system:

• Periodic inventory: cost is calculated only at the end of the period, after a physical count. Simple, but it gives you neither a live cost figure nor a live inventory balance.

• Perpetual inventory: the inventory balance and its cost are updated after every sale or purchase. You get cost of goods sold and an inventory balance in real time, and shortages and discrepancies surface immediately.

Modern accounting systems run perpetual inventory with a moving weighted average or FIFO automatically, so you get accurate numbers without waiting for the period to close. That is the basis for making pricing and purchasing decisions while they still matter.

• Mixing methods across items with no rationale: it makes comparison hard and invites questions from your auditor.

• Changing the method to flatter profits: it breaches the consistency principle and is easy to spot.

• Ignoring landed costs: correct valuation covers the purchase price plus shipping, customs and insurance, not the invoice price alone.

• Failing to write down damaged or slow-moving inventory: inventory must be measured at the lower of cost and net realisable value, otherwise your assets are inflated on paper.

• Relying on manual spreadsheets: with many batches at many prices, manual calculation accumulates errors that grow into the balance sheet and the Zakat base.

Snad applies inventory valuation in real time, with no manual calculation:

• Automatic perpetual inventory: the balance and cost of every item are updated after each sale and each purchase.

• Automatic cost of goods sold: calculated using your adopted valuation method, so the true gross profit shows per item and per invoice.

• Landed costs included: shipping and customs are allocated across item costs for an accurate valuation.

• Alerts for stagnant and near-expiry inventory: so you can decide to clear stock before it turns into a loss.

• Consistency with the financial statements and Zakat: the same inventory value feeds the balance sheet and the Zakat base, so the numbers never contradict each other.

Try Snad free for 30 days, enter purchase batches at different prices, and watch gross profit and inventory value calculated in real time with no manual error.