Ecommerce accounting basics: The Principles to a Profitable Store

A successful business in e-commerce requires more than good ideas, products, marketing, and inventory. It also requires an accounting system to follow the money. How much are you spending? How much are you making? Are you in line with your budget for your business? Do you have the approval of the government for your business? Ecommerce accounting uses well-known processes for keeping track of your financial data and business transactions and keeping up to date on taxes as well as payroll and profit.

Whether you're just beginning your online store, or have been at it for a little while and realize that you require help in tracking your company's financials, this accounting guide will assist you in getting going in the right direction.

Ecommerce accounting empowers you to evaluate the financial condition of your business and make more accurate financial projections when the business expands.

What does ecommerce accounting involve?

The foundation of ecommerce is the transactions that happen and also inventory. The company makes the sales. You ship goods. You buy and replenish inventory.
The basics of ecommerce accounting begin with a system for tracking and reporting transactions. This includes purchases bills, orders, expense, and taxes.

But it goes much further beyond this. Accounting firms will then utilize the data they collect and it to prepare financial statements that allow them to evaluate and present the financial condition of your business.Ecommerce firms also require particular attention to meet the basic principles of the business model.

Consider what happens when you make a sale in your online store. That means the customer uses their credit card and submits payment to your payment processor. What are all the ways this sale can impact your cash flow?

• Your payment processor has received funds, but it's not yet in your bank account.
• Sales tax is a cost in a variety of ways, and may be incurred from a different region or state
• Inventory declines
• The credit card or payment processor costs are added to the charges
• The actual income from sales differs from the sales price

Whichever sales channel you choose, making even a single sale touches on numerous areas of your financial record. The repercussions from the sale will show up on your financial statements in the coming months. In the event that your order is to be returned, a lot of these transactions must now be reverted or altered.

This is just one of many sales.

The tracking of some of this is the task of a bookkeeper, and we'll go over the difference between ecommerce bookkeeping and accounting some time later.

Let's start with the most basic accounting terminology.

Basic accounting terms

These are the top phrases to learn for ecommerce accounting:

Transactions

A transaction happens any time money is transferred, spent, or demanded from a company or a vendor.

An transaction can be one of the following:

• Money the business owner invests in the business
• Revenue from sales
• Invoices
• The expenses include wages, marketing, travel, and construction costs
• Purchased assets, like vehicles, office equipment, property, or materials

One transaction may have multiple components. When you pay an hourly worker like this it is important to determine the amount of time they worked, their gross wages, tax deductions and their net pay. A good accounting program can perform all of these functions.

Ecommerce transactions may be complicated due to particular factors, such as taxation and delays in timing that result from the disconnection between consumer and business.

As an example, would you apply sales tax when you purchase? If yes, what happens to that amount if the item is returned a month later?

The accounting for ecommerce attempts to handle the processes and transactions so that the aforementioned issues do not affect the financial outlook of your enterprise.

Credits and debits

Every transaction is tracked through an accounting system that tracks debits as well as credits. First, let's define the most important concepts:

Debit A document of the money taken from your bank account. The debits will show on your bank statement whenever you buy something.

Credit: A record of the funds that was deposited into your account.

Assets Properties (real as well as intellectual) held by an entity.

Liabilities are obligations that a company has to meet but need to be met. The term "liability" refers to a claim against the asset shown in a balance report.

Equity Amount of assets after debits were taken out of them.

Now, we can examine how these concepts contribute to what's called the accounting principal equation

    Assets = Liabilities + Equity (Owner's or the Corporation's)  

A debit is added on the left of the equation. It is an asset. A credit is added to the right.As a simple example for an offer of $500, the $500 is debited, and then added to your business assets. It is also added to the owner's Equity through income. When something is debited, something else must be compensated, since this keeps the equation balanced.

This is a simplified explanation, however it will give you an idea of what the accounting software will be doing when you input transactions.

Cost of products sold (COGS)

Accounting for e-commerce must pay special attention to the cost of the goods sold. This refers to all the expenses required for selling a product, not counting items like marketing or payroll.

COGS will cover all the costs of inventory which include purchasing, storage, managing, and shipping. The cost of inventory is one of the largest expenses for an online seller, so if you don't possess a precise accounting view of the expenses of products being sold, the margin of profit as well as your tax-deductible income could be in error.

A faulty COGS can make difficult to determine what to spend on marketing, what prices to set, how much stock to purchase, whether you should hire employees, as well as how much storage space to buy.

Profit margins

Margins are the amount of money that your company earns when an offer has been accepted. The way to calculate margins is this equation:

    Margin = (Revenue + Cost of Goods) + Revenue  

In essence, it's your net profits expressed in a percentage. If you sell the equivalent of $10,000 worth of merchandise within a week, and your COGS on these products is $3000 the margins will be 70%%.

Accounts receivable and accounts payable

These terms refer to money that has not yet changed hands, but is slated to.

Accounts receivable includes any money that is due to arrive in your bank account. As an example, if for example you mail an invoice, it will be placed into accounts receivable till the customer actually pays the invoice.

It works the exact way in reverse. When your company makes a purchase from a vendor, and that vendor sends you a purchase order, it goes in the accounts payable account until you complete the transaction.

Bookkeeping and accounting for e-commerceWhat's the distinction?

There is some overlap between bookkeeping and financial accounting. In general, however, the difference is that bookkeepers process events, and accountants compile and analyse those events in order in order to provide a precise and valuable picture of your budget.

When a sporting analogy can help, bookkeepers are like the announcer of play-by-play accounting professionals are similar to the analyst or color commentary. The bookkeeper keeps track of what occurred. The accountant tells you what this means.

What is an ecommerce bookkeeper do?

Bookkeeping tasks focus primarily on the recording of transactions, and financial institutions. If you have employees, the bookkeeper manages payroll. They can also handle things like:

• Process invoices
• Send receipts
• Keep track of what goes in and what goes out of the business bank account
• Record inventory purchases
• Consolidate your bank accounts each month
• Produce monthly financial statement
• Prepare year-end financial statements as well as tax documents

Accurate ecommerce bookkeeping will aid you in creating a stable and reliable business model.

What does an ecommerce accountant do?

An ecommerce accountant will do things like:

• Monitor and analyse operational costs and business performance
• Conduct financial forecasting
• Review your financial statements, including those from your bookkeeper
• Plan your tax strategy, which includes filing taxes
• Review the cash flow management

The goal of the accountant is to help ecommerce business owners make informed financial decisions.

Are you able to afford an employee who isn't yours? Are you able to expand into new country or state? What's the minimum price you must cost for new products?

Ecommerce accounting in its most efficient form can answer these types of questions.

The accounting methods used by e-commerce sellers

There are two primary methods of ecommerce accounting -either the cash method or that of accrual. The accrual method is the more popular one and, depending on the size and nature of your business, could be legally required.

The primary difference between methods is when the transaction is acknowledged.

Cash basis accounting

Cash basis accounting is the method used to record transactions. a transaction is recognized when the actual amount of money been transferred. If you are able to pay for an invoice, the cash basis accounting declares it as an expense. When you receive the invoice during January but you settle it in March, cash accounting marks it as a charge in March.

Income works the same way. Suppose you make a sale, and the customer signs for a monthly payment plan to spread their payment over four months. With cash accounting, you take this income as a monthly one each month the money comes in.

Accrual method accounting

When accounting for accrual transactions, a transaction is deemed to be completed when the work has been completed and the invoice sent. If you make an order for fresh paper for office in January, and then put it on your business credit card. You receive the office paper immediately, but you do not actually purchase it until February, after which the statements for your credit card accounts arrive.

In accrual accounting it is the moment you receive the document. The receipt is taken keep it in your filing system and record the expense. The expense is for January, regardless of the fact that you won't be paying for it until the month of February.

The same scenario applies to accrual accounting. accrual accounting would record the entire purchase price as an income at the time the purchase is made even though you won't actually receive all the money until four months have passed.

Which type of accounting approach is more suitable for businesses that sell online?

Accrual accounting provides you with an easier understanding of the cost of goods sold each month. If you buy paper in August, that paper was part of the cost for running your business- in August, not when you actually arrive at paying the bill. If you make a sale in May, it was a sale that occurred during May, not July, the month when the client finally pays the bill.

Also, it works well in conjunction with managing inventory.

Suppose you make $30,000 in purchase of inventory in September. You then are able to sell it in the four months before the holiday season. With cash accounting, you will mark your entire purchase of inventory as a cost at the end of September. If you use accrual accounting, you would mark it as an expense when you sell the item.

By using the cash-based approach, you'd have a big expense in September as well as artificially high profit margins in October, November, and even December since it appears as though you've no cost of selling goods.

Accrual accounting allows you to reconcile the costs of doing business every month, and you will know what months have the best profits.

Three primary financial statements

If you are planning outsourcing your accounting for e-commerce and bookkeeping, you need to know how to understand and comprehend your financial reports. If you're working on this by yourself, using an ecommerce bookkeeping software to enter the transaction details will help you to create three most important financial statements which include income statements (also known as "profit and loss report" (also known as P&L), balance sheets, as well as cash flow statements.

Statement of income

Income statement reports profit earned over the specified time period like a month. This profit is what people mean when they use the term "bottom line." The profit you earn is your net income. If you've lost money during that time period, your net loss.

Balance sheet

Balance sheets provide information on your assets, liabilities, and equity as of a certain date, usually at the close of the month, quarter, or even a year. It's a snapshot of your financial situation.

Assets are items owned by a person that have significance. Liabilities, including accounts payable are the things you owe.

If you look back at the fundamental accounting equation that was discussed earlier, you'll see that equity simply is the difference between assets and liabilities. Add liabilities to assets and you'll have the "book value," also known as equity, your company.

Cash flow statement

The cash flow statement reports what your money in your account has changed over the time.

Each of the three reports are easily generated by your accounting software, provided you've taken care to enter your financial details. If you're not able to make time for that, this is another reason why you should hire an ecommerce bookkeeper.

Important financial metrics that are essential for eCommerce accounting

Taxjar put out a great article on ecommerce accounting metrics. Be aware that accounting is not just recording financial data. Accounting also tells the story of the financial condition as well as the growth or decline of your online business.

These are the most important accounting parameters:

Revenue

Revenue refers to your gross receipts, before any expenses have been subtracted. It is relatively simple to track. But by itself this gives an incomplete view.

Contribution margin

This is the selling price minus the cost to sell the product. It's similar to the COGS number from earlier however, it is for every single product that you sell. It doesn't include operational expenses.

Profit

Profit results when you subtract all of costs from the revenue that includes marketing and operational expenses. If your revenues are high however your profit margins aren't as high, you either need to improve your revenue or cut expenses.

Conversion rate for eCommerce

This is the percentage of people who come to your store who buy something.

Cost of acquisition for the customer

In general, it is a lot less to make extra sales to your current customers compared to acquiring a new customer.

If your CAC is high, and you're not willing to stop your marketing, you have two options:

1. You can improve or enhance your marketing
2. Begin to market more effectively to your existing customers

Customer lifetime value

If you're only a new eCommerce seller, you'll be having a tough time making this decision for the first few years. With a good accounting system it will be possible to estimate this amount in the future.

This number helps you justify your marketing expenses. In other words, if your CAC is high, however, your lifetime value of the customer is much higher, then it's worth the cost to acquire the customers.

Average order value

For e-commerce startups that are relatively new, this is a better metric to use than the longevity value. If you spend $10 to get a customer however they'll spend on average $25 per purchase, it's a great deal, provided that the other costs aren't excessive. If you can scale that upwards as you gain more clients, you'll be able to do well.

Cart abandonment rate

This is a shockingly high number for ecommerce stores. Based on TaxJar's sources approximately 70% of shoppers who shop online add items to their carts, but don't buy them.

The best way to reduce decreasing abandonment of your cart is to email abandoned cart email messages, which is easy to automate with the right email platform, such as the MailPoet.

If you could lower the cart abandonment rate down to 60 or 50 percentage, it will result in a sizable increase in revenue. All it takes is a couple of automated emails then it's no problem.

Rates for refunds and returns to customers

Are there a large number of customers who return products for a refund? This is a sign that something is going wrong. Be aware of it and do your best to lower it.

Five essential ecommerce accounting issues to take on

If you're at the beginning phases of being an e-commerce business owner, you must to master your basic accounting tasks soon to avoid ending with hot water in the future. To be clear"hot water" could mean many different things, including:

• Taxes that are not paid -- income tax, sales tax, or state and local taxes
• Tax filings that are not correct
• Overspending on inventory
• Employees you're not able to afford
• Insufficiently withdrawing equity

Below are a few steps you can take to get your ecommerce accounting process off to a great beginning:

1. Create a separate business bank account

Ecommerce small business owners tend to forget about their business's future because they're involved with their other business startup tasks.

But business accounting becomes very complicated when you mix personal with business transactions. Your business account is what will be used for all of the business costs as well as where you'll deposit income from sales.

For opening a bank for business account, you'll need a corporate tax ID.

2. Prepare for employees and contractors

If you plan to have employees, you'll have establish procedures to collect withholding tax. Although you may plan to run the business by yourself for the moment there's a chance that you'll still need to contract with contractors for specific tasks. Contractors that are paid over an amount each an year throughout the U.S. must be sent a 1099form. Be certain to

• Keep track of who you've paid and the amount you've paid them.
• Get a W-9 form from every contractor
• Make sure you have current addresses in your file for all employees you have

3. Find accounting software

If you expect to have hundreds or thousands of transactions each month, you'll need accounting software like QuickBooks Online, Xero, or FreshBooks. Companies with less transactions may get away with using an Excel spreadsheet, however those with lots of transactions will not have the capacity to keep up by manually entering data.

Ecommerce accounting software can automate a lot of the most important accounting chores and makes your life easier. It stores, records, and retrieves financial information as well as produces financial statements and reports.

4. Make sure to keep all receipts, invoices and records of payments

The Reliability Principle of Accounting states that transactions that have supporting documents should be documented. If there aren't any records of the transaction that you don't have documentation for, it's not able to be counted as income or an expense. If you tried to claim tax benefits for an expense you have no evidence of having paid for, that could be called tax fraud.

Maintain receipts in physical form. Take photos and store them digitally. Make sure to keep all invoices and receipts in separate email folder too, not just your general email inbox.

5. Be aware of taxes and tax regulations

Tax laws vary drastically based on the kind of business and its location. It is important to be aware of sales tax compliance, import tax if you are involved in overseas transactions. Tax withholding tax withholding for quarterly payments, as well as any other taxes that apply to your state, nation, province, city, or area.

The tax will be incorporated into the accounting software you use and your financial reports. It's always best to seek out a tax expert to ensure you're following the correct procedures.There's a lot more to talk about tax administration. There are two major taxes you'll have be aware of:

Taxes on sales and trackers

Sales taxes for online sales have turned out to be extremely complex. The majority of US states now has an online sales tax and the EU has its own taxes on sales.

The U.S., each state is charged at different rates and also has its own set of rules for how sales tax should be applied.

The payment of estimated quarterly business tax

Business income is pre-tax. Just like a 1099 employee the business you run through ecommerce earns money before any taxes have been paid.

And like a 1099 employee You must pay your quarterly income tax. If you do not then the government can punish you for not paying in paying your tax bill.

How do you manage this? It is important to stay clear of falling way behind on your taxes. The best way to manage tax obligations for the quarter is to set the amount you will pay from your monthly income which you can use to pay taxes estimated every quarter.

The accounting software you use can manage all of this, and also the sales tax requirements. Software is a must...

The reasons your business should use accounting software

It's worth some time to revisit this question and ensure you understand that there are advantages to employing software for managing your ecommerce accounting tasks.

First, as you've just discovered, tax management has become extremely challenging particularly the tax on sales and revenues from multiple sales channels. If you run an online business that sells products across the US or across a huge number of states, you'll not enjoy trying to manage everything on your own. You have a business to run.

Your program will also handle the tax amount you'll need to pay income taxes, and will assist in the filing your tax year-end reports. If you're also being subject to local or state taxes, the complexity increases further. A good accounting program is able to meet all the requirements.

Second, accounting software makes it much easier to monitor your earnings and expenditures by creating financial statements, which will let you track your monthly profit margin as well as your company's equity.

The third benefit of accounting software is that it helps to manage the payroll of employees on contract. If you don't want to cover the cost of the bookkeeping and financial management of e-commerce it is a must to have accounting software.

Should you hire bookkeepers and accountants or should you do it yourself?

If you're not using the accounting program, or if you do get it but you don't want to use it, you'll need to hire a bookkeeper. As your company grows, you'll eventually also need to look at some of the numerous accounting companies who are aware of the specifics of businesses that rely on e-commerce.

Some business owners in the e-commerce industry enjoy the concept of running their own business, including acting as the Chief Financial Officer. And so long as their business is small, you might be able to get away in this way. But let's define "small."

If an online retailer is making up to $100,000 or more each year in net income it's likely become beyond the reach of your accounting system when you're selling goods in several states or nations. Sales taxes on their own get too complex.

You also have to deal with returns, shipping charges, shipping, and all other issues. Most ecommerce platforms sell lower-priced products, and deal in volume. If yours is not an exclusion, it means you will have many transactions.

More transactions mean more time is required to track and record everything. And even a "small" online business that earns less than $100,000 of net income annually selling goods that range from $5 to $20 will have a lot of transactions.

Now, if your business does not sell in a specific region, state, province, or even a country, the level of tax complexity will go lower. In that scenario, you might be able to do the tax yourself should you wish to take on the extra work.

You can test your preferred method and observe how it works. You are able to alter your mind in the future.

Does accounting have a cover

recognizes the responsibilities that business owners have each day. The manual process of entering transactions and preparing accounting reports can be very tedious and tax planning may create a mess Accounting is a crucial aspect of running a successful business.