What They Are, Why They Matter, and How to Use Them in Ecommerce
🧾 What’s the Difference?
1. Cost Type (aka Costing Method)
This defines how your system calculates the value of inventory and determines cost of goods sold (COGS) when items are shipped. The two most common cost types are:
- FIFO (First In, First Out):
The system assumes the oldest inventory (by receive date) is sold first. Cost is pulled from the oldest received batch. - Weighted Average:
Each time inventory is received, the cost of that item is recalculated as an average across all on-hand units. The next time it’s sold, that average is used as the item’s cost.
đź“Š When to Choose FIFO vs. Weighted Average
| Cost Type | When to Choose | Best For |
| FIFO | - You want true cost accuracy that reflects changing supplier prices - You often experience price changes across POs - You sell perishable or batch-tracked goods | - Fashion brands with seasonal pricing - Food/bev with expiration dates - B2B with large, varied PO costs |
| Weighted Average | - You want simplified cost calculations - Your product costs stay relatively stable over time - You want to smooth out fluctuations across POs | - DTC brands with consistent pricing - Companies with high SKU volume - Subscription boxes or bundled goods |
🔍 Why Would a Company Choose One Over the Other?
FIFO Pros
- More accurate cost tracking if prices vary over time
- Helps identify margin erosion when supplier prices increase
- Ideal for inventory that has expiration dates or product life cycles
FIFO Cons
- Slightly more complex to manage, especially across multiple warehouses
- Can create margin “noise” if the same product was purchased at drastically different prices
Weighted Average Pros
- Smooths out cost swings across receipts
- Simpler and faster for accounting/reporting
- Reduces manual reconciliation when landed cost data is inconsistent
Weighted Average Cons
- Less precise when costs change frequently
- Can mask cost increases and distort margins on fast-moving SKUs
📦 2. What is Cost Allocation Type?
This determines how additional costs like freight, customs, or duties are spread across the items on a receiving order.
Examples of Allocation Types:
- Unit-based: Evenly across all units
- Weight-based: Proportional to weight
- Volume-based: Based on cubic volume
- Value-based: Based on item price or declared value
These allocation settings help accurately calculate landed cost per item, especially when shipments include mixed products or when some items are heavier/more valuable than others.
🛍️ How to Use in Ecommerce Operations
Your Cost Type:
- Impacts how profit margins are calculated.
- Informs your pricing strategy.
- Affects how you recognize COGS on financial reports.
Your Cost Allocation Type:
- Impacts how much cost gets assigned to each SKU during receiving.
- Helps maintain accurate per-unit profitability.
- Especially important when importing goods, paying for bulk shipping, or receiving mixed SKU shipments.
âś… TL;DR Summary
| Concept | Cost Type (FIFO vs. Weighted Avg) | Cost Allocation Type (Unit/Weight/Value/Volume) |
| What it is | Inventory valuation method | Landed cost distribution method |
| Impacts | COGS, profit reporting, margins | Unit-level cost of inventory during receiving |
| Use level | Set at product or system level | Set globally or per receiving order |
| When to adjust | Based on pricing volatility and accounting needs | Based on shipment characteristics (e.g., heavy, valuable SKUs) |