For retailers, wholesalers and distributors, efficient inventory management is one of the keys to business success. These companies often have considerable amounts of money invested in stock that’s intended for sale to customers. For many companies, this inventory of goods for sale — known as merchandise inventory — is their most valuable asset; automobile dealers, for example, may have millions of dollars tied up in vehicle inventory. A company’s ability to manage its merchandise inventory can affect its profitability, competitiveness, customer satisfaction and, ultimately, its survival.
What Is Merchandise Inventory?
Merchandise inventory is so called because retailers, wholesalers and distributors make money by buying goods from manufacturers or other suppliers and then merchandizing — that is, marketing and selling — those products to customers. Merchandise inventory is the manifestation of the value of the goods a retailer or other reseller intends to sell to customers. It includes the goods the company holds in all locations — including storage facilities, warehouses and retail stores.
- Merchandise inventory comprises the goods that retailers and resellers have purchased with the intent to sell to customers.
- Merchandise inventory is categorized as a current asset on the company’s balance sheet. For some retailers, it is their biggest asset.
- Efficient tracking of merchandise inventory is critical to managing expenses, profitability and customer satisfaction.
- Merchandise inventory calculations can also be useful in performing inventory reconciliation, uncovering inventory shrinkage, identifying and recording inventory tax write-offs, and determining optimal inventory and ordering strategies.
- Companies can track merchandise inventory with perpetual or periodic inventory systems. A perpetual automated system is more accurate than a periodic manual approach.
Merchandise Inventory Explained
Merchandise inventory includes all goods that have been purchased but not yet sold. This unsold inventory is categorized as a current asset on a company’s balance sheet. Current assets are assets that the company expects to sell or consume within a year, and merchandise inventory fits that definition because companies generally expect to sell inventory within a year through normal business operations. The value of merchandise inventory includes the price paid to suppliers plus associated costs, such as transportation and insurance.
Why Is Merchandise Inventory Important in Accounting?
Merchandise inventory has an impact on the company’s current assets, accounts payable, expenses and profit, which are all important measures of the financial health of a business. Therefore, accurately accounting for merchandise inventory is critical. Here’s how it works: A retail store buys additional volumes of a product that is in short supply. The retailer records the cost of the shipment in the merchandise inventory account, which is an asset account. It’s not treated as an expense until the retailer sells the goods. When the goods are sold, their cost is deducted from the merchandise inventory account and added to the cost of goods sold (COGS) expenses for the period. This directly affects the company’s gross profit for the period, because gross profit is calculated by subtracting COGS from net sales.
What Does Merchandise Inventory Include?
Merchandise inventory includes a range of costs a retailer incurs in the course of obtaining the products it intends to sell to its customers. It includes the price paid for the goods, shipping costs paid by the resellers or retailer and any other associated expenses, such as transit insurance and packaging. Merchandise inventory includes all goods the company has purchased, from items in warehouses and retail stores to goods that are still in transit from suppliers.
Merchandise Inventory on Income Statements
While merchandise inventory is represented as an asset on the company’s balance sheet, it does not directly appear on the company’s income statement, which reports revenue, expenses and profit or loss during a specific accounting period. However, changes in merchandise inventory during each period are reflected as expenses on the income statement. That’s because when merchandise inventory is sold, its cost is included in the COGS expenses on the income statement for that period.
Merchandise Inventory Turnover
Merchandise inventory turnover is an important business metric for retail operations’ management and strategy. Inventory turnover, also known as the inventory turnover ratio, is a measure of how quickly a company sells its inventory; it reflects the number of times a business sells and replaces its inventory during a given period. The inventory turnover ratio for an accounting period is calculated by dividing COGS by the average inventory during the period.
Tracking inventory turnover can help businesses drive pricing strategies, promotions, supplier and warehouse management and more. Generally speaking, high merchandise inventory turnover is desirable. It indicates that a retailer has better liquidity because it isn’t tying up too much of its money in unsold inventory. However, merchandise inventory turnover varies by industry. Grocery stores and fast-fashion retailers typically have higher inventory turnover, while high-end luxury retailers will have much lower turnover rates.
Merchandise Inventory Methods
Merchandise inventory can be measured in one of two ways — using a perpetual inventory system or a periodic system. A periodic system involves waiting until the end of an accounting period to tally unsold merchandise via physical inventory counts. Because inventory can be such a large and important part of a retailer’s total assets, even companies that use a perpetual system often conduct a physical inventory count at the end of each accounting period to check that their records are accurate.
Perpetual inventory method. Most large retailers and an increasing number of other companies take this approach. Their POS systems automatically record product sales and update merchandise inventory in real time. As each item is sold, its cost is removed from the current asset account and added to COGS. This reduces the possibility of human error when calculating inventory. It also gives business a real-time view of current inventory levels and key business and financial metrics such as inventory turnover and COGS.
Periodic inventory method. Smaller retailers may opt for the periodic method. This relies on physical inventory counts typically performed at the end of each accounting period; there’s no automated real-time inventory tracking. In some cases, retailers may perform a physical inventory count only at the end of each fiscal year, although it’s usually advisable to do physical counts at least quarterly or after high-demand periods. This manual inventory tracking approach is more prone to manual error than the perpetual method, and it means companies lack a real-time view of inventory levels and associated inventory metrics.
How to Calculate and Track Merchandise Inventory
In order to calculate the ending merchandise inventory at the close of an accounting period, a retailer must know the beginning merchandise inventory value, the total amount spent on additional merchandise inventory and COGS.
Calculating beginning merchandise inventory. The beginning (or opening) merchandise inventory is the value of inventory at the start of the period, before procuring any more inventory items or selling any existing inventory. The beginning inventory for the current period is simply the ending merchandise inventory value from the previous period.
Calculating merchandise inventory. The company adds to the beginning inventory the amount spent on additional inventory during the period. It then subtracts COGS. The formula is:
Ending merchandise inventory = beginning inventory + new inventory costs - cost of goods sold (COGS)
How merchandise inventory calculations are used. Merchandise inventory calculations have many uses beyond preparing the company’s balance sheet and income statements. Companies can use the calculations for inventory reconciliation, for example. Comparing the calculated inventory values with the results of physical inventory counts can help companies identify and address issues such as inventory shrinkage due to accounting errors, theft, spoilage or other factors. Inventory calculations can also be used to identify inventory write-offs for tax purposes. In addition, retailers may use trends in inventory to determine optimal ordering strategies.
Merchandise Inventory Examples
There are as many examples of merchandise inventory as there are finished goods that an individual or business might buy from a retailer or wholesaler. Anything that a retailer has on hand to sell to customers — clothing, computers, cars, cheese, crackers — falls under the category of merchandise inventory.
Only finished goods ready for sale are counted as merchandise inventory; if a company makes furniture using lumber, fasteners and glue and then sells the furniture to customers, only the finished chairs and tables are included in merchandise inventory.
Manage Merchandise Inventory With NetSuite
Manually tracking merchandise inventory with spreadsheets or pen and paper is both inefficient and error-prone. Inventory management software helps even small and midsize organizations automate merchandise inventory tracking, leading to increased productivity, fewer mistakes and an improved customer experience by having merchandise on hand. NetSuite Inventory Management enables retailers to track inventory in real time wherever it is located: at warehouses, retail stores and logistics providers. It provides companywide visibility that enables retailers to optimize their inventory processes, better manage stock, decrease cost of goods sold, and boost profitability. Real-time analytics help businesses monitor trends, quickly spot problems and drive better performance over time.
For retailers, distributors and wholesalers, efficiently tracking and managing merchandise inventory is critical to the company’s financial health. Applying inventory management software can help companies decrease expenses, increase profitability and improve customer satisfaction.
Merchandise Inventory FAQ
What is an example of merchandise inventory?
Merchandise inventory is the cost of finished goods (COGS) that a retailer or wholesaler has available to sell to its customers during a given accounting period. For a bookstore, merchandise inventory would include the cost of the books or magazines it has for sale. For an automobile dealer, it would be the cost of cars and trucks.
Is merchandise inventory an asset?
Yes. Merchandise inventory is considered a current asset. Current assets are assets that the company expects to sell or consume within a year.
What type of account is merchandise inventory?
Merchandise inventory is an asset account. Merchandise inventory is reported as a current asset on a retailer’s balance sheet. A current asset is one that will provide an economic benefit during a given accounting period, typically a year. Merchandise inventory qualifies because it is expected to be sold during a fiscal or calendar year.
Why is merchandise inventory important for accounting?
Tracking merchandise inventory is critical for retailers, wholesalers or distributors in order to accurately calculate their assets, expenses and overall profitability. For many companies, merchandise inventory is one of the biggest assets recorded on the balance sheet. When merchandise is sold, its costs are recorded as part of COGS on a company’s income statement. COGS is then used to calculate gross and net profit.
What should be included in merchandise inventory?
Merchandise inventory includes the amount the retailer or other reseller paid for the items themselves, as well as additional costs incurred by the company such as shipping, insurance and storage. Merchandise inventory includes all unsold stock that is ready for sale, whether it’s located in stores or warehouses.