Most e-commerce businesses use FIFO, which stands for First In, First Out. This method assumes your oldest inventory gets sold first, and the remaining inventory reflects your most recent purchase costs. For online retail, this typically matches how you actually move products and keeps your books aligned with reality.

The three main options are FIFO, LIFO (Last In, First Out), and weighted average cost. LIFO assumes you sell newest inventory first, which can lower taxable income when prices rise. However, LIFO is rarely used in e-commerce because it doesn’t reflect how most online sellers actually operate, and it’s not allowed under international accounting standards if you sell globally. Weighted average cost calculates a single average cost across all units, which works but can obscure margin trends when your purchase prices fluctuate.

FIFO wins for most online retailers because it’s straightforward, widely accepted, and produces a balance sheet inventory value that reflects current costs. If product costs are rising, FIFO will show higher profits and a higher inventory value compared to LIFO. That’s something to factor into your decision, but for most small business bookkeeping situations, FIFO is the practical choice.

What you include in inventory cost matters as much as which method you pick. Don’t just record the product price from your supplier. Include shipping to your warehouse, customs duties if you import, and any other costs required to get products ready for sale. This “landed cost” approach gives you accurate margins and prevents understating your inventory value.

Whatever method you choose, stay consistent. The IRS requires you to use the same valuation method from year to year. Switching methods requires approval and creates complications. Pick a method that makes sense for your business and stick with it.

Your e-commerce platform and accounting software need to work together for accurate tracking. Platforms like Shopify track quantities, but your accounting system needs to track costs correctly. If you’re buying the same product at different prices over time, your accounting software should handle the FIFO calculation when units sell. QuickBooks Online has inventory features, but they require proper setup to value inventory correctly.

When inventory gets complicated from multiple warehouses, international suppliers, or high SKU counts, consider working with someone who specializes in inventory accounting. Getting inventory valuation wrong flows through to your cost of goods sold, your profit margins, and ultimately your tax return. The numbers compound, and fixing errors after the fact takes more time than setting it up right from the start.