Merchandising companies, in contrast to service-type businesses, earn revenue by selling goods rather than services. The goods that a merchandising company sells to its customers are called inventory (or merchandise), regardless of the type of products that the company sells. Thus, the inventory of an auto-mobile dealership consists of auto-mobiles offered for sale, whereas the inventory of a grocery store consists of a wide variety of food items.
Merchandising companies often have large amounts of money invested in their inventories. In fact, inventory is one of the most costly assets appearing in the balance sheets of most merchandising companies. Fortunately, inventory is a relatively “liquid” asset—that is, it usually will be sold within a few weeks or months, thereby generating accounts receivable and cash receipts. For this reason, the asset inventory appears near the top of the balance sheet, immediately below accounts receivable.
The “Operating Cycle” of a Merchandising Company
The series of transactions through which a business generates its revenue and its cash receipts from customers is called the operating cycle. The operating cycle of a merchandising company consists of the following basic transactions (1) purchases of merchandise; (2) sales of the merchandise, often on account; and (3) collection of the accounts receivable from customer. The word cycle suggests, this sequence of transactions is repeated continuously. Some of the cash collected from the customer is used more merchandise, and the cycle begins anew.
This continuous sequence of merchandising transactions is illustrated in the following diagram:
Merchandising Activities Compared with Manufacturing
Most rnerchandising companies purchase their inventory from other business organizations in a ready-to-sell condition. Companies that manufacture their inventories, such as General Motors, Apple Computer, and Boeing Aircraft, are called manufacturers, rather than merchandisers. The operating cycle of a manufacturing company is longer and more complex than that of a merchandising company, because the first transaction— purchasing merchandise—is replaced by the many transactions involved in manufacturing the merchandise.
Retailers and Wholesalers:
Merchandising companies include both retailers and wholesalers. A retailer is a business that sells merchandise directly to the public. Retailers may be large or small; they vary in size from giant department store chains, such as Sears and Wal-Mart, to small neighborhood businesses, such as gas stations and gift shops. In fact, more businesses engage in retail sales than in any other type of business activity.
The other major type of merchandising company is the wholesaler. Wholesalers buy large quantities of merchandise from several different manufacturers and then, resell this merchandise to many different retailers. As wholesalers do not sell directly to the public, even the largest wholesalers are not well known to most consumers. Nonetheless, wholesaling is a major type of merchandising activity.
Income Statement of a Merchandising Company
Selling merchandise introduces a new and major cost of doing business: the cost to the merchandising company of the goods which it resells to its customers. This cost is termed the cost goods sold. In essence; the cost of goods sold is an expense; however, this item is of such importance to a merchandising company that it is shown separate from other expenses in the income statement,
A highly condensed income statement for a merchandising business is shown on the following page. In comparison with the income statement of a service-type business, the different features of this statement are the inclusion of the cost of goods sold and a subtotal called gross profit.
Revenue from sales represents the sales price of merchandise sold customers during the period. The cost of goods sold, on the other hand represents the cost incurred by the merchandising company in purchasing these goods from the company’s suppliers. The difference between revenue from sales and the cost of goods sold is called gross profit (or gross margin).
Gross profit is a useful means of measuring the profitability of sales transactions but it does not represent the overall profitability of the business. A merchandising company has many expenses other than the cost of goods sold. Examples include salaries, rent, advertising, and depreciation. The Company only earns a net income if its gross profit exceeds the sum of these other expenses.