Chapter 16
Financial Merchandise Management
Dr. Pointer’s
Notes
Chapter Objectives
 To describe the major aspects of financial
merchandise planning and management
 To explain the cost and retail methods of
accounting
 To study the merchandise forecasting and
budgeting process
 To examine alternative methods of inventory
unit control
 To integrate dollar and unit merchandising
control concepts
16-2
Financial Merchandise
Management
 With Financial Merchandise Mgmt, a retailer
specifies which products are purchased, when
products are purchased, and how many products
are purchased
* Dollar control involves planning and monitoring
a retailer’s financial investment in merchandise
over a stated period
* Unit control relates to the quantities of
merchandise a retailer handles during a stated
period
16-3
Benefits of
Financial Merchandise Plans
 The value and amount of inventory in each
department and/or store unit during a given
period are delineated
 The amount of merchandise a buyer can
purchase during a given period is stipulated
 The inventory investment in relation to
planned and actual revenues is studied
 The retailer’s space requirements are partly
determined by estimating beginning-of-month
and end-of-month inventory levels
16-4
Benefits of
Financial Merchandise Plans_2
A buyer’s performance is rated. Measures
may be used to set standards
Stock shortages are determined and
bookkeeping errors and pilferage are
uncovered
Slow-moving items are classified – leading
to increased sales efforts or markdowns
A proper balance between inventory and
out-of-stock conditions is maintained
16-5
Inventory Valuation: The cost
and retail methods of accounting
There is a need to develop a retail
inventory accounting system
Retailers have different data needs than
manufacturers, cost estimation is more
difficult, stock shortages higher, sales
more frequent and they require monthly
not quarterly profit data
Two inventory accounting systems are
available
16-6
Inventory Valuation: The cost
and retail methods of accounting
 Dollar control system provides data on sales and
purchases, value of beginning and ending
inventory, markup and markdowns and
merchandise shortages.
 Merchandise available for sale = beginning
inventory, purchases and transportation charges
 Cost of goods sold = cost merchandise available
minus cost value of ending inventory
 Gross profits = sales less cost of goods sold
 Net profit = gross profits – operating expenses
16-7
Table 16.1 Handy Hardware Store
Profit-and-Loss Statement
Sales
$417,460
Less cost of goods sold:
Beginning inventory (at cost)
Purchases (at cost)
Transportation charges
Merchandise available for sale
$ 44,620
289,400
2,600
$336,620
90,500
Ending inventory (at cost)
$246,120
Cost of goods sold
$171,340
Gross profit
Less operating expenses:
Salaries
Advertising
25,000
Rental
16,000
Other
26,000
Total operating expenses
Net profit before taxes
16-8
$ 70,000
137,000
$ 34,340
Inventory Accounting Systems
1. The cost accounting system values
merchandise at cost plus inbound
transportation charges
2. The retail accounting system values
merchandise at current retail prices
16-9
Cost Method of Accounting
 The cost to the retailer of each item is recorded
on an accounting sheet and/or is coded on a price
tag or merchandise container
 Can be used with physical or book inventories:
* Physical inventory – actual merchandise is
counted at closed of a specified period of time
* Book( perpetual) inventory – keeps a running
total of the value of all inventory on hand at
cost based on records. No need for actual
counting of stock. Frequent financial
statements can be prepared.
16-10
Physical Inventory System
Ending inventory - recorded at cost – is
measured by counting the merchandise in
stock at the close of a selling period
Gross profit is not computed until ending
inventory is valued
Gross profit derived during full
merchandise count
16-11
Book Inventory System
Keeps a running total of the value of all
inventory on hand at cost at a given time
End-of-month inventory values can be
computed without a physical inventory
Frequent financial statements can be
prepared
16-12
Book Inventory System _2
 Types of book inventories
FIFO- logically assumes all old merchandise is
sold first. Most reasonable but results in higher
taxes
LIFO – assumes new merchandise is sold first.
Results in lower profits and lower taxes and
understated ending inventory
Both are acceptable ways to value merchandise
16-13
Disadvantages of Cost-Based
Inventory Systems
Requires that a cost be assigned to each
item in stock
Do not adjust inventory values to reflect
style changes, end-of-season markdowns,
or sudden surges of demand
Works best for retailers low inventory
turnover, limited assortment and high
average prices (car dealers)
16-14
Table 16.2 Handy Hardware Store
Perpetual Inventory System
Date
Beginning-of-Month
Inventory
Net Monthly
Purchases
Monthly Sales
End-of-Month
Inventory
7/1/03
$90,500
$40,000
$ 62,400
$68,100
8/1/03
68,100
28,000
38,400
57,700
9/1/03
57,700
27,600
28,800
56,500
10/1/03
56,500
44,000
28,800
71,700
11/1/03
71,700
50,400
40,800
81,300
12/1/03
81,300
15,900
61,200
36,000
TOTAL
$205,900
$260,400
(as of 12/31/03)
16-15
The Retail Method
Closing inventory is determined by
calculating the average relationship
between the cost and retail values of
merchandise available for sale during a
period
16-16
Determining Ending Inventory Value
 1. Calculating the cost complement
Cost
Total Cost valuation
Complement = Total retail valuation
$299,892/496,126 = .6045 therefore, .60 of every retail
sale went cover costs (Table 16.3)
 2. Calculating deductions from retail value
Table 16.4 shows ending value of $59,552
 3. Converting retail inventory value to cost
$56, 470 X .6046 = $34,136
(Ending Inventory value at cost) This can be used to find
gross profit.
16-17
Table 16.3 Handy Hardware Store, Calculating
Merchandise Available for Sale
at Cost and at Retail
Beginning Inventory
Net Purchases
At Cost
At Retail
$ 90,500
$139,200
205,900
340,526
Additional Markups
Transportation Charges
Total Merchandise Available
16-18
__
3,492
$299,892
16,400
__
$496,126
Table 16.4 Handy Hardware Store, Computing
Ending Retail Book Value
Merchandise available for sale (at retail)
$496,126
Less deductions:
Sales
Markdowns
Employee discounts
Total deductions
Ending retail book value of inventory
16-19
$422,540
11,634
2,400
436,574
$ 59,552
Table 16.5 Handy Hardware Store, Computing
Stock Shortages and Adjusting Retail Book Value
Ending retail book value of inventory
Physical inventory (at retail)
Stock shortages (at retail)
Adjusted ending retail book value of inventory
16-20
$ 59,552
56,470
3,082
$ 56,470
Table 16.6 Handy Hardware Store,
Profit-and-Loss Statement
Sales
$422,540
Less cost of goods sold:
Total merchandise available for
$299,892
sale
Adjusted ending inventory
34,136
Cost of goods sold
$265,756
Gross profit
$156,784
Less operating expenses:
Salaries
Advertising
25,000
Rental
16,000
Other
28,000
Total operating expenses
Net profit before taxes
16-21
$ 70,000
139,000
$ 17,784
Advantages of the Retail Method
 Valuation errors are reduced when conducting
a physical inventory since merchandise value
is recorded at retail and costs do not have to
be decoded
 Because the process is simpler, a physical
inventory can be completed more often
 Profit-and-loss statement can be based on
book inventory
 Method gives an estimate of inventory
throughout the year and is accepted in
insurance claims
16-22
Limitations of the Retail Method
 Bookkeeping burden of recording data
 Ending book inventory figures correctly computed only
if the following are accurate:
* Value of beginning inventory
* Purchases
* Shipping charges
* Markups
* Markdowns
* Employee discounts
* Transfers
* Returns
* Sales
 Cost complement is an average based on the total cost
of merchandise available for sale and total retail value
16-23
Merchandise forecasting and
Budgeting: Dollar Control
Dollar control entails planning and
monitoring a firm’s inventory investment
over time to ensure profitable operations
The six steps involved in the process are
outlined
16-24
Figure 16.2 The Merchandise Forecasting
and Budgeting Process: Dollar Control
Designing
control units
Sales
Forecasting
Planning
profit margins
Planning
Purchases
16-25
Inventory
level planning
Reduction
Planning
Merchandise forecasting and
Budgeting: Dollar Control
 Control Units –merchandise categories for which
data are gathered. Categories is the broadest
control units (women’s shoes, men’s suits)
Classification merchandising – each department is
sub divided into further categories women’s
shoes and dress shoes and casual shoes
Standard classification – recognized classification by
trade association and industry.-
16-26
Merchandise forecasting and
Budgeting: Dollar Control
Forecasting – estimating revenues
(companywide, departmental or
categories). Yearly sales can be broken
down by months.
Monthly sales index, divides ach month’s
actual sales by average monthly sales and
multiples by 100.
Index allows a retailer to project sales by
month
16-27
Table 16.7 Handy Hardware Store,
A Simple Sales Forecast Using
Product Control Units
Product Control Units
Actual Sales
2003 ($)
Projected Growth/
Decline (%)
Sales Forecast
2004 ($)
Lawn movers/ snow blowers
200,000
+10.0
220,000
Paint and supplies
128,000
+ 3.0
131,840
Hardware supplies
108,000
+8.0
116,640
Plumbing supplies
88,000
-4.0
84,480
Power tools
88,000
+6.0
93,280
Garden supplies/ chemicals
68,000
+4.0
70,720
Housewares
48,000
-6.0
45,120
Electrical supplies
40,000
+4.0
41,600
Ladders
36,000
+6.0
38,160
Hand tools
36,000
+9.0
39,240
Total year
840,000
+4.9
881,080
16-28
Table 16.8 Handy Hardware Store,
2003 Sales by Month
Month
Monthly Actual Sales ($)
Sales Index
January
46,800
67
February
40,864
58
March
48,000
69
April
65,600
94
May
112,196
160
June
103,800
148
July
104,560
149
August
62,800
90
September
46,904
67
October
46,800
67
November
66,884
96
December
94,792
135
Total yearly sales
Average monthly sales
Average monthly index
16-29
840,000
70,000
100
Table 16.9 Handy Hardware Store, 2004
Sales Forecast by Month
Month
Actual Sales
2003 ($)
Monthly Sales Index
Monthly Sales Forecast 2004
January
46,800
67
73,423 * .67 = 49,193
February
40,864
58
73,423 * .58 = 42,585
March
48,000
69
73,423 * .69 = 50,662
April
6,600
94
73,423 * .94 = 69,018
May
112,196
160
73,423 * 1.60 = 117,477
June
103,800
148
73,423 * 1.48 = 108,666
July
104,560
149
73,423 * 1.49 = 109,400
August
62,800
90
73,423 * .90 = 66,081
September
46,904
67
73,423 * .67 = 49,193
October
46,800
67
73,423 * .67 = 49,193
November
66,884
96
73,423 * .96 = 70,486
December
94,792
135
73,423 * 1.35 = 99,121
Total Sales
840,000
Average monthly sales
16-30
70,000
Total sales forecast
881,080
Average monthly forecast
73,423
Merchandise forecasting and
Budgeting: Dollar Control
 Inventory –Level Planning- need to have sufficient
inventory to meet sales
 Basic Stock Method - carries more inventory than
you expect to sales
Beg month inventory = planned sales + basic stock
Percentage variation method
Weeks Supply Method
Stock to sale method – maintain a specified ratin of
goods on hand to sales ( 1.3 ratio means sales of
$69K mean inventory of $89K)
16-31
Merchandise forecasting and
Budgeting: Dollar Control
Reduction Planning – retail reduction is the
difference between beginning inventory
plus purchases , sales plus ending
inventory
Planned Purchases =sales for month=
planned reductions + planned end of
month stock – beginning of month stock
16-32
Merchandise forecasting and
Budgeting: Dollar Control
Planning profit margins – Determines the
average markup needed to reach the
projected profits
Required initial markup = planned
expenses +planned profits + planned
reductions/planned net sales + planned
reductions
16-33
Unit Control Systems
Deals with quantities of merchandise in
units rather than in dollars. Information will
reveal- best selling items,identify problems
and opportunities, optimal time to reorder,
book inventory, old merchandise,
alternative sources for goods and level of
sales of each item in every branch
16-34
Unit Control Systems
 Physical Inventory Systems -counts number of
units by item classification
 Perpetual Inventory Systems - keepings running
total of inventory based on sales and purchases,
returns, transfers and other transactions
94% of retailers engage in physical inventory
systems
57% of retailers use cost inventory systems
68% of retailers use a perpetual inventory system
16-35
Financial Control: Integrating
Dollar ad Unit concepts
Stock Turnover – number of times during a
specific period, usually a yr, that the
average inventory on hand is sold.
Computation of stock turnover
stock turnover = # of units sold during year
units
average inventory on hand
Annual stock = net yearly sales
Turnover $
average inventory on hand
16-36
Stock Turnover
 Average stock turnover will vary by industry
 Normally want to have high stock turnover
 High stock turnover is usually a sign of success
 Gross Margin Return on investment (GMROI)
shows relationship between the gross margins in
dollars and the average inventory investment by
combining profitability anal sales to stock
measures
good indicator of managers performance
16-37
When to Reorder
 Reorder point – set stock levels at which new orders must
be placed
 Order lead time- period from the date an order is placed by
a retailer to the date merchandise is ready for sale
(received, price marked and put on selling floor)
 Usage rates –average sales per day, in units of
merchandises
 Safety stock-the extra inventory that protects against out of
stock conditions due to unexpected demand and delays in
delivery
reorder pt = usage rate X lead time
Reorder pt + usage rate X lead time + safety stock
Automatic reordering systems – mechanically activated when
stock on hand reaches the reorder point
16-38
Figure 16.6a
How Stockouts May Occur
1. Unexpected Demand
2. Delayed Delivery
16-39
How Much to Reorder
Economic Order quantity (EOQ) is the
quantity per order that minimizes total
inventory costs of processing orders and
holding inventory.
EOQ= quantity per order
EOQ=
D= annual demand
2DS
IC
16-40
S= costs to place an order
I= % of yearly carrying
cost to unit cost
C= unit cost of an item
Questions
Please read this chapter carefully
16-41