7.7 Budgeting in a Merchandising Company

Budgeting in merchandising companies

Budget preparation for merchandising companies and service companies is similar to budgeting for manufacturing companies.   A service or merchandising company will not have a production budget or direct material budget and may not have a direct labor or overhead budget.  The largest difference is since we do not have a production or materials purchase budget, we still need to know how much inventory we need to buy for a merchandiser.  The merchandise purchases budget is similar to the production budget.  The purchases budget can be done in units or in total dollars.  Typically, the purchases budget is done in dollars and will use a cost of goods sold percentage to determine the cost of inventory sales. Remember, cost of goods sold is literally the cost of the inventory we are now selling and should be less than what we can sell it.  This section discusses budgeting in merchandising companies.

Throughout this chapter, we have focused on budgeting in a manufacturing company. Suppose managers in a retail merchandising business, such as a dress shop or a furniture store, prepare a budget. In this case, the company prepares a purchases budget instead of a production budget. To compute the purchases for each quarter, management must estimate the cost of the goods to be sold during the quarter and the inventory required at the end of the quarter.

Suppose Strobel Furniture Company prepared a sales budget showing sales of $30,000 in the first quarter, $80,000 in the second quarter, $50,000 in the third quarter and $40,000 in the fourth quarter. Assume the company maintains sufficient inventory to cover one-half of the next quarter's sales. Cost of goods sold is 55% of sales. The ending merchandise inventory this year is expected to be $11,000. The purchases budget can now be prepared.  We need the following information:

  • Sales, from the Sales budget
  • Cost of goods sold percentage (can also be shown as gross margin or gross profit percent which would be subtracted from 100 to get the cost of goods sold percent)
  • Desired ending inventory policy
  • Beginning inventory balance (if not provided, you can follow the same ending inventory policy and apply to first quarter sales.)  Remember, beginning inventory of one quarter is the ending inventory of the previous quarter.

Strobel's merchandise inventory budget would look like:

Strobel Furniture Company    
Merchandise Purchases Budget    
  Qtr 1 Qtr 2 Qtr 3 Qtr 4
SALES (in dollars)

$30,000 $80,000 $50,000 $90,000
Cost of goods sold (Sales x 55%) $16,500 $44,000 $27,500 $49,500
Add: Desired ending inventory (1/2 of next quarter's cost of goods sold) $22,000 $13,750 $24,750 $11,000
Total inventory needs $38,500 $57,750 $52,250 $60,500
Less: Beginning merchandise inventory ($8,250) ($22,000) ($13,750) ($24,750)
Budgeted Purchases (in dollars)

$30,250 $35,750 $38,500 $35,750
Important items to now:

  • Sales is used in the calculation for cost of goods sold but is not part of the budget itself.
  • Cost of goods sold takes the Sales dollars x 55% cost of goods sold percentage.
  • Desired ending inventory is next quarter's cost of goods sold x 50% or divided by 2.  For fourth quarter, the information is given in the example problem.
  • Beginning inventory equals the ending inventory of the previous quarter for all except for first quarter.  For first quarter, we assume the same rules were followed for ending inventory in the previous year so we can calculate as first quarter cost of goods sold $16,500 / 2.

Strobel can now use the information in its purchases budget to prepare the cost of goods sold section of the budgeted income statement, to prepare cash disbursements schedules, and to prepare the inventory and accounts payable amounts in the financial budget.

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