What Accounting is Needed for a Trading Business
Trading businesses have a major asset which most service businesses do not. That asset (known as ‘stock’, ‘merchandise’ or ‘inventory’) is unique in character – it is obtained by the businesses for one purpose only – that is – selling to customers. Unlike other assets which are obtained and retained by a business, a trading business must rely on the constant sale of this asset for its survival. Because of this, trading businesses need to be able to account for this asset and the individual lines of merchandise which make it up.
A trading business sells goods as its primary source of revenue. A newsagent, chemist, sports shop, clothing store, butcher, supermarket are all trading businesses because they earn most of their revenue through the sale of goods.
This is in contrast to service businesses, which rely on the ability to provide some type of service to customers; for example, dry cleaners, doctors, electrician, plumber, accountant, etc.
There are, however, many businesses which both sell goods and provide services. A trading business may provide services as well as sell goods. A service business may sell goods as well as provide services. However, businesses are classified according to their main source of revenue.
In accounting, the goods sold by a business are referred to as stock, inventory or merchandise.
The accounting needs of a trading business differ from those of a service business because of the existence of inventory, which is also known as trading stock. Inventory includes all goods purchased by a trading business for the purpose of resale, which usually occurs at a higher price than the cost of the purchased item.
The operation of a trading business creates a need to record both the buying and the selling of such goods. This is in addition to the usual recording needs of the typical service business.
The definition of trading inventory excludes some items which may be sold from time to time by a business. Non-current assets such as equipment and vehicles may be sold for a profit at the end of their useful life. However, when such assets are purchased, they are usually purchased with the intention of not reselling the items to generate a profit. An owner of a business usually buys non-current assets with the intention of owning them for several accounting periods for the purpose of earning income.
For example, a sporting store may have non-current assets such as shop fittings, office furniture and a computer. The inventory of such a business would include footballs, tennis rackets, sport shoes, gym equipment, etc. If the business was a furniture retailer Office Furniture would be in the inventory (as well as furniture items that are regarded as non-current assets).
The owners of a trading business require different information from those involved with a service business.
As trading businesses rely on buying and selling merchandise, the owner of the business will need to know a great deal more about the goods handled by the business. For example: the cost of goods sold, the fast and slow moving items, and which items are most profitable, are all important pieces of information for a trading business.
In a trading business, the cost of goods sold is normally the largest single expense of the business. The owner will need to control this expense in order to maximise profit. While a service business may use materials in the production of revenue, the cost of materials has less of an impact on the profitability of the business than the cost of goods sold has on a trading business.
In a trading business, the owner must also know the amount of any stock loss due to theft or damage, and the percentage mark-up on the merchandise sold.
The amount of stock on hand needs to be sufficient to meet the normal day to day demands of customers. Remember, however, the more money spent on buying stock, the less money there is available to pay other bills or to start new and profitable projects. As a result, the owner is constantly in discord between keeping enough stock on hand to meet the demands of customers and minimising the amount of stock on hand so that cash is available to pay bills or undertake new projects.
The number of transactions involving stock and the importance of the data collected about those transactions means that an accounting system will need to be set up to record purchase and sale of stock efficiently and effectively. Many small businesses use computers to make recording the purchases and sale of merchandise a lot easier.
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