Which Inventory Costing Method Fits Restaurants? [FIFO, LIFO or WAC]

Key takeaways

• FIFO (First-In, First-Out) is the most suitable inventory costing method for restaurants, especially those dealing with perishable goods. It supports food safety practices, reduces spoilage, and often results in lower cost of goods sold and higher net income.

• LIFO (Last-In, First-Out) is generally not recommended for restaurants. It's better suited to non-perishable inventory and is banned under IFRS due to its potential to distort financial statements.

• WAC (Weighted Average Cost) works well for inventory items that are indistinguishable or identical, such as beverages. It provides a middle-ground cost valuation that’s easy to calculate and track.

• Choosing the right inventory costing method helps restaurants better manage food costs, improve profitability, and ensure accurate financial reporting. Software tools like Toast’s inventory system can streamline tracking and compliance.

When it comes to running a profitable restaurant, a lot of what you need to know comes down to the way your restaurant manages inventory. Often, the financial health of your business depends on the stock management of your perishable goods and the cost control measures you take when ordering them, which means tracking all your ingredient costs — even small things like broccoli prices.

But let's be honest: No one really likes doing inventory. That's why there are inventory costing methods. When you stick to one, it can help make the process of managing and costing inventory easier — and more profitable.

Inventory costing methods

What's the best inventory costing method to determine the cost of goods sold in food establishments?

You actually have a few options here:

• First-in, first-out (FIFO)

• Last-in, first-out (LIFO)

• Weighted average cost (WAC)

In this article, you'll learn about each of these inventory costing techniques and determine which makes the most sense for your business.

1. What is FIFO? 

FIFO stands for first-in, first-out (FIFO), a popular principle of inventory valuation that many restaurants use. It's a term that originates in financial accounting, but the concept is also applicable to food storage and inventory management.

This technique assumes that the goods you purchase first are the goods you use (and sell) first. As a result, your remaining inventory consists of your most recent purchases and is accounted for at the goods' current cost.

What does FIFO require?

The first-in, first-out method is best for businesses where inventory has a short demand cycle or is perishable, which is most prominent in the restaurant industry. Chefs and back-of-house staff will use the ingredients purchased first, with the nearest expiration date, in order to avoid spoilage and food waste in their inventory. The FIFO system makes sense because it matches the actual flow of safe food quality in the kitchen and helps reduce the risk of foodborne illnesses caused by expired or improperly stored ingredients.

Why use the FIFO method?

With supply chain issues and fluctuating costs impacting the food industry, restaurants can find themselves in an inflationary environment. But for those using the first-in, first-out method, the financial hit is minimized. FIFO practices direct restaurants to use older, lower-priced goods first and to leave the (theoretically) more expensive goods as inventory. Altogether, this adds up to a lower cost of goods sold and higher net income — a direct benefit to the bottom line.

Altogether, this adds up to a lower cost of goods sold and higher net income, contributing to cost savings. Using the FIFO principle not only helps reduce food waste but also supports food safety practices by ensuring older products are used before they expire, lowering the risk of cross-contamination.

Implementing FIFO in restaurants

Of all inventory valuation methods, first-in, first-out is the most reliable indicator of inventory value for restaurants. Because this method corresponds to inventory with its original cost, the calculated value of remaining goods is most accurate. Managers can even access real-time depletion and inventory counts instantly through a modern inventory management system, like Toast’s Inventory-Management. 

This simplifies audits and compliance with food safety standards, and also stock rotation and the management of storage areas, improving your ability to manage inventory and avoid issues with expired products.

One thing to consider with this method is that revenue and cost matching don't always match up. With FIFO, older and often lower costs are calculated with current revenues, resulting in some incorrect correlations.

2. What is LIFO?

Last-in, first-out (LIFO) is another technique used to value inventory, but it's not one commonly practiced, especially in restaurants. This method is often used for non-perishable goods but is not ideal for food products, which are usually perishable with limited shelf life.

Last-in, first-out values inventory on the assumption that the goods purchased last are sold first at their original cost. In this scenario, the oldest items usually remain as ending inventory. Under the LIFO system, many food items and goods would expire before being used, so this method is typically practiced with non-perishable commodities.

When the price of goods increases, those expensive and newer items are used first according to the LIFO method. This increases the overall cost of goods sold and leaves the cheaper, earlier purchased goods as inventory, which may end up not even being sold under the LIFO model.

Should restaurants use LIFO?

The short answer is, no.

The higher cost of goods sold brought on by the LIFO model and will ultimately yield lower restaurant profit margins and net income. Also, unlike FIFO, the last-in, first-out method doesn't always provide an accurate valuation of closing inventory. Since your older items  tend to be used repeatedly to store food, a significant portion will likely become obsolete before you can use them.

And as it relates to financial accounting, LIFO is also banned by the International Financial Reporting Standards (IFRS). More on this from Investopedia:

3. What is WAC?

Depending on the inventory items, FIFO and LIFO may not be viable options for inventory valuation. An alternative and generally accepted method is weighted average costing (WAC).

According to Investopedia, WAC is: 

"Most commonly employed when inventory items are so intertwined that it becomes difficult to assign a specific cost to an individual unit. This is frequently the case when the inventory items in question are identical to one another. Furthermore, this method assumes a store sells all of its inventories simultaneously”.

How to calculate weighted average cost

With the WAC technique, the inventory items receive the same valuation regardless of when and at what cost each was purchased. Instead, the total cost of items in inventory is divided by the number of units to yield the weighted average cost per unit.

WAC = ( Total Cost of Sitting Inventory ) / (Number of Units)

Here's an example: Maybe you want to lump your soft drink inventory together for more convenient calculations. Perhaps some of the cases are $24 for 24 bottles, but you also choose to buy a more premium drink that costs $36 for 24 bottles. Assuming you buy the same amount of cases for each price point — say, 10 at the $24 price and 10 at the $36 price — your WAC per beverage case is $30, or $1.50 per bottle.

In comparison to the techniques above, the weighted average method generates a valuation between that of FIFO and LIFO. The value assigned in this case represents a cost between the first and last purchased goods.

Inventory costing methods: Pros, cons & summary

While FIFO, LIFO, and WAC are all accepted methods for inventory valuation, you should select the one that best aligns with your reporting and management styles. The easiest way to monitor your product quality is by using back office software that integrates with your point of sale system and gives you live tracking of your inventory — whenever you need it.

Inventory costing is an extremely useful and powerful tool for managing an important piece of your restaurant's finances, and keeping a close eye on it will help you maintain the financial health of your business.

And to go deeper on food inventory, check out Toast's Recipe Costing Software.

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