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Merchandise Inventory: What Merchandise Inventory Includes

Monday, October 12, 2020

Merchandise inventory is one of the types of inventory that directly and substantially impacts a company’s financial health.

  • The total amount of assets, in which merchandise inventory is included, impacts a company’s solvency, or ability to meet its financial obligations.
  • Merchandise inventory turnover rate reflects a company’s ability to sell its products. It gives you a metric to focus on improving to enhance your sales pipeline.
  • A company’s Cost of Goods Sold (COGS), one of the most important measurements of a profitable, successful business, is based in part on merchandise inventory figures.

Ignore merchandise inventory and you immediately squander an opportunity to enhance the health of your business. Embrace it—learn everything you can about it—and you’ll have taken one of the biggest steps toward profitability a company can take.

What Is Merchandise Inventory?

Merchandise inventory is all the goods that a distributor, wholesaler, or retailer acquires from manufacturers that are intended for sale. Typically wholesalers and retailers are the only businesses with merchandise inventory. That’s because, fundamentally, merchandise inventory is goods that are intended to be resold at a higher price than they were acquired for. Manufacturing inventory, MRO inventory, and raw materials inventory are not considered merchandise inventory.

Merchandise Inventory Includes ...

Merchandise inventory includes all acquired goods intended for resale that are in transit from suppliers, in company storage facilities, on customer-facing displays, and as consignment inventory in other locations.

What Is Merchandise On Hand?

Merchandise on hand is the cost of goods on hand and available for sale at any given moment. Merchandise on hand is a type of merchandise inventory. It does not include the cost of goods that are in transit—but it does include finished goods inventory, goods held on consignment, and safety stock.

Is Merchandise Inventory an Asset?

Merchandise inventory is reported as an asset. There are two main types of assets: current and noncurrent.

Noncurrent assets include long-term investments, intangible assets like intellectual or technological property, and physical property and equipment. Current assets, on the other hand, are assets that can be reasonably expected to be converted into cash within one operating cycle or fiscal year.

Merchandise inventory is classified on the balance sheet as a current asset.

Why Is Merchandise Inventory a Current Asset?

A current asset is an asset that provides economic benefit during a given year or operating cycle. Think of anything that can be reasonably expected to be sold or used during that time frame. Merchandise inventory is one of the clearest examples of a current asset because it’s usually liquidated within a year of being produced or acquired.

What Type of Account Is Merchandise Inventory

Merchandise inventory is the account on a balance sheet that reflects the total amount paid for products that are yet to be sold. As a current asset, merchandise inventory is basically a holding account for inventory that’s waiting to be sold. It has a normal debit balance, so debit increases and credit decreases.

Merchandise inventory is not only reflected on the balance sheet, but also used to calculate COGS.

Merchandise Inventory On Income Statement

Merchandise inventory is not an income statement account. It’s an asset, and its ending balance is reported as a current asset on your balance sheet. Cost of Goods Sold (COGS), however, is on your income statement and changes in your merchandise inventory affect your COGS.

The cost of any merchandise inventory sold during an accounting cycle is reported as an expenditure on the income statement for the cycle in which the sale was made. Any merchandise inventory not sold during an accounting cycle is registered as a current asset and included in the balance sheet until it’s sold.

Merchandise Inventory Turnover

Tracking merchandise inventory turnover is a good way to understand how efficiently your company controls merchandise. Specifically, you should work toward establishing and maintaining high merchandise inventory turnover.

High merchandise inventory turnover shows two things:

  1. You’re not needlessly keeping money tied up in sitting inventory
  2. How liquid your inventory is

If you’ve got cash tied up in stock that’s moving and you can’t sell products, you’re headed down a troubling road. A high merchandise inventory turnover means your company smoothly turns merchandise into cash. Whether that's because of a VMI inventory agreement, expertly managed pipeline inventory, or good old fashioned in-house inventory control, any company that does that is a healthy one.

Here’s how to calculate inventory turnover.

Merchandising Inventory Methods

There are two primary merchandising inventory methods: perpetual and periodic. 

Perpetual Merchandising Inventory

The perpetual merchandising inventory method maintains an ongoing tally of quantity and value of your merchandise inventory. Every time stock is added or removed, the balance is adjusted.

Perpetual inventory is virtually impossible to implement without automation, unless your business sells a low volume of high-cost items, like a car dealership. But the easiest way to establish perpetual merchandising inventory is to automate your inventory with software.

Periodic Merchandising Inventory

The periodic merchandising inventory method does not maintain an ongoing tally of inventory quantity and value. Instead, inventory is taken at specific intervals. To determine changes in merchandising inventory, the results of two inventories are compared.

Periodic inventory is often used by two types of businesses.

  • Smaller businesses that are able to manually account for their inventory in a reasonable amount of time. And don’t need or have the resources for automation software.
  • Businesses that sell low-value items in such high volume that perpetually tracking such a massive amount of small inventory changes doesn’t make sense. Think of a hardware store selling all sorts of nuts, bolts, and screws. Or a candy shop selling individual pieces of hundreds of types of candy. The granular inventory management or perpetual inventory loses some of its value when there are so many transactions.

Periodic inventory tends to be inaccurate, though. It’s often manually done and prone to human error. It also doesn’t provide any real-time insights into your COGS, turnover rate, or other inventory metrics that successful businesses let inform their day-to-day decision making.

How to Calculate Merchandise Inventory

Calculating merchandise inventory uses multiple fields from your company’s income statement. Specifically from the COGS section of the income statement.

To calculate merchandise inventory, you’ll need:

  • Beginning inventory
  • Inventory purchased
  • COGS

If you don’t have those specific values, you can use the below formulas to calculate them. All below values are in USD.

How to Calculate Beginning Merchandise Inventory

Here’s how to calculate beginning merchandise inventory:

Beginning Inventory = (Ending Inventory + COGS) - Inventory Purchased

Take, for example, a company that sells 12-ounce bags of coffee for $15 each. Their last accounting period ended with a total of 400 bags of coffee on the books, unsold. Over the accounting period, they sold 1,000 bags and purchased 500.

Beginning Inventory = ($6,000 + $15,000) - $7,500
Beginning Inventory = $13,500

Calculating Merchandise Inventory

To calculate merchandise inventory, you take the cost of goods available for sale minus COGS. Here’s how to calculate merchandise inventory:

Merchandise Inventory = Cost of Goods Available for Sale - COGS
Merchandise Inventory = (Beginning Inventory + Purchased Inventory) - COGS
Merchandise Inventory = ($13,500 + $7,500) - $15,000
Merchandise Inventory = $6,000

We can consider “merchandise inventory” to be the ending inventory amount because that’s what gets reported on the balance sheet. According to the above calculation, your business has $6,000 worth of inventory ready to be sold.

Quiz: The Following Statements Regarding Merchandise Inventory Are True Except

Here’s a merchandise inventory quiz to reiterate some of the more important points from this post.

The following statements regarding merchandise inventory are true:

  1. Merchandise inventory is reported as a noncurrent asset on the balance sheet
  2. Merchandise inventory is the same as WIP inventory
  3. Examples of current assets on a balance sheet are cash and merchandise inventory
  4. Merchandise inventory is not expected to be sold within a year
  5. Merchandise inventory is the cost of goods available for sale minus the cost of goods sold for a given period of time

If you chose 1, 3, and 5 you are correct! You are a merchandising inventory genius.

The following statements regarding merchandise inventory are true except:

  1. Merchandise inventory is an account that shows how much value a company holds in products it has yet to sell
  2. A high merchandise inventory turnover rate is a healthy indicator for a business
  3. Merchandise inventory includes property, equipment, and intangible assets like intellectual property

If you chose 3, you are correct! You are truly a merchandising inventory genius.