For most retail businesses, FIFO is the better choice. It matches how you actually move product, keeps your balance sheet accurate, and avoids the compliance headaches that come with LIFO.

FIFO means First In, First Out. The oldest inventory you purchased is assumed to be sold first. LIFO means Last In, First Out, where the most recent purchases are matched against sales. Neither method tracks actual physical items. They’re just accounting conventions for assigning costs to what you sell versus what remains on the shelf.

FIFO works better for retail for several reasons.

It matches reality. Retail stores rotate stock so older product sells first. Clothing, electronics, seasonal merchandise, anything with changing styles or potential obsolescence gets moved out before new inventory. FIFO reflects this natural flow. LIFO assumes you’re somehow selling the newest stuff first, which doesn’t happen in practice.

Your balance sheet stays accurate under FIFO. The inventory value reflects recent purchase costs. Under LIFO, that balance sheet number includes costs from purchases made years ago, sometimes at prices that have nothing to do with current market values. This creates a distorted picture of what your inventory is actually worth.

LIFO also creates administrative burdens. You have to maintain detailed records of each inventory “layer” going back years. If you ever liquidate old inventory, you trigger a profit spike from selling at outdated costs. Most small retailers don’t need this complexity, especially when inventory accounting is already one of the trickier parts of running a product-based business.

International standards don’t allow LIFO either. If you’re selling internationally or have any plans to, LIFO isn’t permitted under IFRS. E-commerce businesses especially should avoid painting themselves into a corner.

The main argument for LIFO is tax deferral. In periods of rising prices, LIFO matches higher recent costs against revenue, showing lower profit and therefore lower taxes. But prices don’t always rise, the tax benefit compounds into a larger future liability, and the bookkeeping burden often isn’t worth the savings for smaller operations.

Once you choose a method, you’re generally stuck with it. The IRS requires consistency, and switching from LIFO to FIFO requires permission and often triggers a taxable adjustment. Better to start with FIFO than to realize later you made the wrong call.

Average cost is another option worth mentioning. Your accounting software calculates a weighted average cost for all units, regardless of when purchased. It’s simpler than tracking layers and works well for high-volume, low-differentiation inventory. Many e-commerce businesses use this approach.

For Phoenix-area retail shops, FIFO is the default recommendation unless you have a specific reason to do otherwise. Your accountant should weigh in at tax time, but for ongoing small business bookkeeping, FIFO keeps things clean and accurate.