Introduction to Merchandising Business

Nature of a Merchandising Business

• A merchandising business earns revenue by buying and selling goods (merchandise inventory).

• It does not mainly provide services like professionals or consultants.

• It profits from the difference between selling price and cost of goods sold (COGS).

Types of merchandising businesses

• Wholesaler

  • Buys goods in large quantities

  • Sells to retailers

• Retailer

  • Buys goods from wholesalers or manufacturers

  • Sells directly to customers

Key idea

• Goods purchased for resale are called merchandise inventory

• Inventory is a current asset until sold

Difference between Service and Merchandising Business

1. Nature of operations

• Service business

  • Sells services only

  • Example: lawyer, accountant, barber

• Merchandising business

  • Sells goods/products

  • Example: supermarket, department store

2. Income generation

Service business

• Revenue comes from service income / fees earned

• No inventory involved

Merchandising business

• Revenue comes from sales of goods

• Must purchase inventory first before selling

3. Income statement structure

Service business

• Service Income

• Less: Operating Expenses

• Net Income / Loss

Merchandising business

• Sales

• Less: Cost of Goods Sold (COGS)

• Gross Profit

• Less: Operating Expenses

• Net Income / Loss

4. Key difference in expense reporting

Service business

• Only operating expenses are recorded

Merchandising business

Expenses are divided into:

• Cost of Goods Sold (COGS)

• Operating Expenses

5. Profit measurement difference

Service business

• Profit = Revenue − Operating Expenses

Merchandising business

• Profit = Sales − COGS − Operating Expenses

Operating Cycle of a Merchandising Business

Meaning

• The operating cycle is the process of:

  • Buying inventory

  • Selling inventory

  • Collecting cash

Cycle flow

Cash purchases and cash sales

• Cash → Inventory → Cash

Cash purchases and credit sales

• Cash → Inventory → Accounts Receivable → Cash

Key goal

• Shorter cycle = faster cash collection

• Faster inventory turnover = higher profitability

Inventory Systems

1. Perpetual Inventory System

Meaning

• Inventory records are updated continuously after every transaction

Features

• Records:

  • Inventory purchases immediately

  • Cost of goods sold at each sale

• Always shows real-time inventory balance

Advantages

• Accurate inventory tracking

• Better control of stock

• Errors are detected quickly

2. Periodic Inventory System

Meaning

• Inventory is updated only at the end of the accounting period

Features

• Purchases recorded in a Purchases account

• COGS is computed at period end

Formula for COGS

• Beginning Inventory

• Purchases
  − Ending Inventory
  = Cost of Goods Sold

Key difference

• Perpetual → updated every time

• Periodic → updated at period end only

Why Physical Count is Needed (Periodic System)

• No continuous record of inventory exists

• Ending inventory must be determined manually

Steps in physical count

• Count all merchandise on hand

• Multiply quantity × cost per unit

• Add all values to get total ending inventory

Importance of ending inventory

Ending inventory affects:

• Cost of Goods Sold

• Gross profit

• Net income

• Balance sheet inventory value

Effects of errors in inventory

• Understated ending inventory:

  • COGS increases

  • Profit decreases

  • Assets and equity decrease

• Affects current and future accounting periods

Activities of a Merchandising Business

A. Operating Activities

1. Sales

• Accounts affected:

  • Cash / Accounts Receivable

  • Sales Revenue

  • Sales returns, discounts

2. Purchase of goods

• Accounts affected:

  • Merchandise Inventory

  • Cash / Accounts Payable

  • Purchase returns and discounts

3. Expenses

• Accounts affected:

  • Expenses (salaries, rent, utilities)

  • Cash or Accounts Payable

4. Interest income

• Cash

• Interest Income

B. Investing Activities

1. Purchase of long-term assets

• Land, building, equipment

• Accounts affected:

  • Asset accounts (PPE)

  • Cash / Payables

2. Sale of long-term assets

• Accounts affected:

  • Cash / Accounts Receivable

  • Asset accounts

C. Financing Activities

1. Owner investment

• Cash

• Capital

2. Loans

• Cash

• Notes Payable

3. Loan payments

• Cash

• Notes Payable

4. Owner withdrawals

• Cash

• Drawings / Capital

Key Summary

• Service business → earns from services only

• Merchandising business → earns from buying and selling goods

• Main difference = presence of inventory and COGS

• Merchandising uses:

  • Gross profit

  • Inventory systems

  • Operating cycle