In this article, we explore what merchandise inventory is and its four methods. We also share our process for calculating merchandise inventory in four simple steps. Read on to learn more.
Merchandise inventory encompasses products a company holds for sale, whether self-produced or purchased for resale. It represents the goods that are either in the process of being sold or will be sold in the near future. When in a retail store, items on the shelves are examples of this inventory.
Example: At Bella's Boutique, the handcrafted jewelry and imported scarves both fall under merchandise inventory. These items, whether created in-house or sourced from abroad, are available for immediate sale or are awaiting upcoming seasonal promotions.
Merchandise inventory includes a broad range of items. However, it depends on the nature of the business. Here are some elements that can be a part of merchandise inventory:
These are products that are ready to be sold without any further modification.
Example: A smartphone available for purchase at an electronics store.
These are products that are still in the production phase and not yet ready for sale. They will become finished goods once they are complete.
Example: A car on an assembly line that is halfway through the manufacturing process.
These are basic materials that will be used to produce a finished good. For a retailer, this might not be as relevant, but for a manufacturer-retailer, raw materials could be part of their inventory.
Example: Cotton used by a clothing company to sew into shirts.
Sometimes, the packaging in which a product is sold can be considered part of the merchandise inventory, especially if it has value or can be reused by the customer.
Example: A branded, reusable tote bag sold by a grocery store for customers to carry their purchases.
Merchandise inventory is an important aspect of a retail business for several reasons. Some of these include:
Inventory represents a significant portion of a company's assets. Selling this inventory will bring in cash, which can be used to meet liabilities.
The main objective for most businesses is to sell inventory at a profit. The faster inventory can be sold (turnover rate), the better it is for the profitability of a company.
A diverse and ample inventory can help a company maintain a robust market presence. It ensures that customer demands can be met promptly, leading to better customer satisfaction.
Tracking which parts of the inventory sell fast and which ones don’t can give insights into market trends, helping businesses adapt to changing consumer preferences.
There are several methods used by businesses to account for merchandise inventory. Let’s explore some of them below:
This method assumes that the oldest inventory items are sold first. It's most relevant for perishable goods where the oldest items need to be sold before they expire.
Example: Imagine a bakery that makes fresh bread daily. The loaves baked on Monday are sold before the loaves baked on Tuesday to ensure customers always receive the freshest product.
Here, it's assumed that the newest inventory items are sold first. This method can be beneficial in inflationary times because it results in higher cost of goods sold and lower profits, hence lower taxes.
Example: A hardware store recently purchased a batch of hammers at a higher price due to supply chain disruptions. When selling, they decide to sell these newer, more expensively acquired hammers first, leading to a higher reported cost on their financials and potentially lower taxable income.
This method averages out the costs of inventory over time to give a balanced view.
Example: A boutique bought 10 dresses in January for $50 each and 20 more in February for $60 each. When one dress is sold in March, its cost is calculated based on the average cost of all dresses, [(10 x $50) + (20 x $60)]/30, which comes out to $57 per dress.
This method is used for high-value items (like jewelry or cars) where each item can be individually identified.
Example: A luxury car dealership sells bespoke vehicles where each car has unique customizations like special paint colors or upgraded features. When a specific car is sold, its exact cost is identified and recorded, rather than averaging or estimating based on other vehicles.
Use our 4-step merchandise inventory process to effectively manage your inventory. Simply follow the steps below:
Start with the value of the inventory at the beginning of the period.
Example: At the start of March, Bella's Boutique had $5,000 worth of dresses in stock.
Add any additional inventory purchased during the period.
Example: During March, Bella's Boutique bought an additional $3,000 worth of dresses to add to the inventory.
Subtract the cost of the inventory that was sold during the period. This is calculated using one of the inventory methods mentioned above.
Example: Over the course of March, Bella's Boutique sold dresses that had originally cost the store $2,500 in total, as per the FIFO inventory method.
Adjust for items that were damaged, stolen, or otherwise rendered unsellable.
Example: Unfortunately, a few dresses at Bella's Boutique were damaged due to a leak in the store, leading to a loss of $500 in inventory value.
The resulting number gives the ending merchandise inventory for the period. Based on the given example, the final merchandise inventory of Bella’s Boutique at the end of March would be $5,000.
Lunar Tech & Gadgets is a popular electronics store known for selling a range of tech products, from smartwatches to high-end headphones. They applied our process below:
At the start of April, Lunar Tech & Gadgets had an inventory valued at $100,000. This included various electronic gadgets like smartphones, tablets, and headphones.
In mid-April, the company anticipated an influx of customers due to an upcoming holiday sale. They ordered and received a new inventory worth $50,000, which included the latest edition of smartphones and some high-end speakers.
Lunar Tech & Gadgets had a successful month in terms of sales, especially during their holiday sale. The cost of the products they sold throughout April, as determined by the Weighted Average inventory method, amounted to $90,000.
Unfortunately, during the shipment of the new inventory, a box containing high-end headphones, valued at $5,000, was damaged in transit and was deemed unsellable.
Using the above information:
The merchandise inventory for Lunar Tech & Gadgets at the end of April would be $55,000.
We hope our article has now left you with a better understanding of what merchandise inventory is and how to calculate it to ensure the overall financial well-being of your business.
If you enjoyed this article, you might also like our article on Codabar barcode format or our article to determine if merchandise inventory is a debit or credit.
