Working of a Trading Firm


Based on the business objectives, a trading firm also referred to as a merchandising firm, is one whose business objective is to buy and sell goods. Their income is mainly from selling goods. Trading companies, whether retail or wholesale, use similar accounting methods. A service firm is different from a trading firm, in that it seeks to achieve profits by providing services. Services could be consultancy or marketing services or accounting services. A service company buys goods for its own use and not for the purpose of selling and making a profit. The main activity of a service company is to provide services to its customer and seeks to earn income mainly from the services they offer. A manufacturing firm is different from a service or a trading firm. A manufacturing firm buys goods and adds value to the goods purchased and sells the goods manufactured to their customers. The value addition could be to make sub assemblies or end products as per the customer´s order. A confectionery unit makes chocolates, which is the end product, from various raw materials. Value is added to the raw materials by different processes and end products are made. So, for a manufacturing firm, the software has to record the purchase of raw materials, record the processes the raw materials undergo and also record the sales being made. The software also has to record the accounting transactions to provide a core functionality. The planning activity for a manufacturing firm is complex and those softwares which cover all these functionalities are called ERP software packages.

This does not mean that there is no planning function required for a trading firm. However, it is simpler in nature as compared to a manufacturing firm´s requirements.

A trading firm typically is in the business of buying of goods and selling the same to the customer. The customer may be an end user or a retailer. A wholesaler is a trading firm, which generally buys from the manufacturer. A retailer is also a trading firm, which buys from the wholesaler. However, while this is the general practice, it need not be true always. In many cases, the buyer and wholesaler and retailer relationship is directly related to the business strategies of each entity. A wholesaler typically expects that his stock is purchased in more numbers. Whereas, a retailer is prepared to sell the goods in minimum possible quantities. All the three entities here, the manufacturer, the wholesaler and retailer have to maintain the inventory of their stock.

It is important to note that the software we develop can be made to address the needs of a trading firm in general and can be easily extended to suit the requirements of different types of traders.

A trading firm, as mentioned earlier buys and sells goods. In this process, it does not add value to the goods purchased. This means the goods purchased remain in the same form. This fact has a large implication on the accounting process. In the book titled Develop an Accounting Package using visual basic we have detailed the basic accounting procedures required for a service firm. Trading activity means that measurement of the goods purchased and subsequently sold will follow a simple process. For instance, an item (many items make goods) like oil purchased in liters will be sold in liters or milliliters. Similarly, an item purchased as a single sheet, will be sold in sheets of smaller sizes. In all these cases, where the items purchased in one unit of measurement and sold in another unit of measurement, the relationship has to be specified.

A trading firm, typically has to deal with a creditor, one who supplies goods to the trading firm, a debtor who buys goods from the firm, a bank which finances the trading firm, and the tax authorities. These four entities have transactions with the trading firm and the software has to cover all these transactions. Further, the software has to meet the special requirements of these four entities and the managerial needs of the trading firm. A trading firm buys goods at a certain price and sells at a marked up price. A portion of the difference in price, constitutes the profit. Trading firms use similar accounting practices like a service firm. However, the accounting of buying and selling goods requires additional concepts.

2. Working of a Trading Firm

In this topic, we will learn about the events which occur in a trading firm. We will also learn about the documents raised for every event occurring in the trading firm.

The external entities to a company are creditor / supplier and debtor / customer. A customer or debtor is one who buys goods from the trading firm. The simplest and a common transaction between a trading firm and the customer is a cash sales transaction. The customer pays the amount in cash and the goods are delivered. The other variation is a credit transaction, wherein the customer pays after a certain number of days, say 15 or 30 or 60 days. The number of days depends on the agreement between the customer and the trading firm. Usually, for each customer, the trading firm maintains a record of all the transactions that occurred between them. The record includes details like the date of the transaction, the names and quantity of goods sold to the customer, the total amount of that particular transaction and the credit terms. This record is also known as a debtor ledger.

Image of working of a trading firm

Whenever a sale is made, an appropriate document is raised which records all the relevant details. When a customer pays by Cash, a Cash Sale Invoice is raised. When the transaction is on credit terms a Sales Invoice is raised.

A supplier is one who sells goods to the trading firm. A supplier supplies goods and collects the amounts due, at a later date. Normally, along with the goods the trading firm receives a copy of the Sales Invoice. The firm on receipt of this copy raises the Purchase Invoice. A record of all the sale transactions between the trading firm and each of the supplier is maintained. This record is also known as creditor ledger. When the trading firm buys goods by paying cash, a Cash Purchase Invoice is raised.


An understanding of the working of a trading firm is essential if you are interested in learning how to develop an inventory software. Inventory software is a key module in an ERP software.