The 10 E-commerce Accounting Principles
The accounting basics you need to know and understand
As bookskeep CEO Cyndi Thomason puts it, “E-commerce businesses are really data businesses” – and we couldn’t agree more!
While most e-commerce sellers don’t get into business for the accounting, its important to understand your numbers if you’re to grow not only a profitable business – but a healthy one too.
bookskeep started like most other e-commerce businesses – out of necessity. As e-commerce specialist bookkeepers, Cyndi and her team help clients towards financial freedom through efficient and smart financial management.
To make sure you’re on the right track, Cyndi has helped us to put together a list of accounting basics that are fundamental to your success. Whether you’re an e-commerce accountant based in the US or an e-commerce business owner looking for support, you’ll be running your business efficiently in no time.
Accounting basics fundamental to success:
- Cash, accrual or modified cash accounting
No one method is better than the others, but its good to understand the benefits of each, so you can determine whether you’re using the right solution for your business.
Cash accounting is the way we handle our personal finances. When you receive money from a sale, it’s considered income. When money goes out, it’s an expense. This method allows you to easily understand your cash flow.
Accrual accounting is more suitable for businesses that deal with inventory. It’s more complicated, requiring you to record revenue from sales when they occur, not when the cash is received. A similar process is required with expenses. This method can help you to understand the longer-term impact of inventory purchases and sales on financial performance.
Finally, modified cash accounting is a blend of the two.
“For small e-commerce businesses, we recommend modified cash accounting because it allows you to match up your revenue with cost of goods sold, so you can understand what your true gross margin is,” Cyndi says.
- Cost of goods sold
Cost of goods sold is treated differently under the different accounting methodologies, but it’s critical if you’re to understand how much you’re making on each of your products before you add in all your expenses.
This is not to be confused with profit. What you sell an item for minus the cost of goods sold is your gross margin. If your accounting software (see number 3) is linked to your e-commerce platform, it should track this automatically for you, but it’s still a term worth being familiar with.
“With modified cash accounting, it’s inventory on your balance until you sell it. Then you put it into your profit-and-loss statement (PNL) so you can match revenue and expense,” adds Cyndi.
- Accounting software
While there are several options on the market, you need what Cyndi refers to as a “true piece of accounting software” – one that has both a balance sheet and PNL functionality.
“You want a system that will give you good data that you can validate. Xero and QuickBooks Online are the most affordable options for small US businesses. They’re also cloud-based, which makes it easier to work with your accounting service provider and tax professional,” she says.
Ultimately, if you want to replace your 9-5 job with your e-commerce business, you’re best to invest in accounting software sooner rather than later.
“If you’re relying on your memory to put something in a system, you run the risk of faulty input,” Cyndi says. “Many times, I’ve seen people make a decision about taking a loan with margins that don’t support it. To make those kinds of decisions, you need good data – and that comes from having a good accounting system.”
- Understanding money at a gross margin level
In her experience, Cyndi says where lots of people get into trouble is not paying attention to their expenses. She adds that if you’re not hitting 30% or above, you’re not making enough to pay your operating expenses.
“At the end of the day, it doesn’t matter how big your top-line number is, it matters how big your bottom-line number is.
“If your bottom line isn’t growing, you’re putting a lot of energy into something this isn’t going to pay off. You aren’t typically innovating or acting in an efficient or frugal way – a critical requirement in the competitive e-commerce space.”
Paying attention and putting pressure on your operating expenses will help your business continue long-term.
- Keeping track of variable expenses
When you hear the term ‘expenses’, most people think tax, interest, fixed costs, but often they’ll forget about variable expenses like advertising and self-development.
“The two big Achilles’ heels that I see with e-commerce business owners in terms of general expenses are advertising – not knowing if they’re getting a return on investment – and the other is education and courses,” explains Cyndi.
“They still need to be paid for somehow,” she jokes.
- Brick-and-mortar versus e-commerce
If you previously owned a retail store before shifting into e-commerce, your biggest challenge will be making the change to a different mode of operating.
As Cyndi mentioned earlier on, “E-commerce businesses are really data businesses” rather than inventory being in your line of sight like a traditional brick-and-mortar store.
“Not necessarily accounting-specific but what I’ve seen happen is more behavioural. You’re managing everything by looking at reports, learning and analysing number patterns so you can make good business decisions.”
- Profit-and-loss statement
Your profit-and-loss statement simply tracks your revenue and cost of goods sold. It’s where you’ll find your gross margin, operating expenses, and then your net margin. The PNL keeps score during the year so you can see month-by-month how your business is going.
“I recommend you compare month-by-month to show you what your monthly activity is, and that will allow you to see the trends of what’s going on – for example, if your revenue is particularly high at a certain time of year,” says Cyndi.
“Also, once you have data for multiple years, you can compare year-to-date info with the prior year-to-date over the same period, to see how you’re performing one year on,” she adds.
- The balance sheet
This report keeps track of the wealth of your business over its lifetime.
For it to be useful, says Cyndi, you need to compare the last end-of-year with where you are now. “Hopefully the value of your assets is growing, and your liabilities are decreasing.”
She says it’s also typically where money is spent without people even knowing.
“My clients will ask, ‘Why am I showing a profit, but I don’t have any money?’ It’s because you’re spending money typically paying down debt, buying inventory or taking owner drawings. Your profit may look good, but your cash situation may be deteriorating because of balance sheet activity.”
- Inventory cash flow
“I feel like people need to really understand the unique cash flow around inventory. It has a very different flavour, timing and rhythm to your operating expenses,” Cyndi explains.
“You need your books to be set up in a way you can match your sales data with your cost data – that’s really important in terms of managing your cash and knowing where your money goes.”
- Getting set up right from the beginning
Whether your goal is building an empire or just turning a profit, starting with the right approach to your accounting will make all difference in the long run.
Working with an e-commerce specialist accountant isn’t always possible straight away, but you still have options – it’s all about starting out right.
“Some companies like bookskeep offer set-up services where we get you going with Xero or QuickBooks. We map your accounting software to A2X for Amazon or Shopify, and we teach you all the ins and outs so you can manage your finances on your own.”
When it comes time to look for more full-time support, that’s when you need to consider turning to the experts.
A2X – pulling it all together
The benefit of adding A2X for Amazon or Shopify to your accounting arsenal is how well it complements all the accounting principles discussed – supporting you to run an even more effective e-commerce business.
Cyndi’s comments on A2X:
- Cost of goods sold – “It does a great job matching up revenue with cost of goods sold so you can better understand your true gross margin.”
- Accounting system integration – “A2X integrates well with both Xero and QuickBooks and makes the recording of your Amazon or Shopify data reconcile seamlessly with your accounts.”
- Tracking monthly performance – “If you’re using something like A2X to push sales and cost of goods data, it does that automatically for you and your numbers are so much easier to work with.”
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