The Fundamentals

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The Basics of Ecommerce Accounting

Estimated reading time: 7 minutes.

ecommerce basics

“Ecommerce businesses are really data businesses."

- Cyndi Thomason, CEO of bookskeep.

Most ecommerce sellers don’t go into business for accounting.

But to run a profitable, healthy business, it’s crucial to understand your numbers.

And for ecommerce, there are a few key definitions and systems that you need to know in order to give yourself the best chance at success.

Regardless of whether you are a seller or an ecommerce accountant needing an overview, this is the place to start.

In this blog, the first part of the A2X Ecommerce Accounting hub, fundamentals series, we’ll be covering the basics of accounting for ecommerce.

You’ll get an overview of bookkeeping methods, financial reports, and what you should be keeping track of when it comes to your business.

Cash, Accrual or Modified Cash Accounting

Let’s kick off with bookkeeping methods.

Business owners have some choice over the way they record their business financials - their method of bookkeeping.

This method impacts the kind of forecasting data you’ll have (or won’t have) for your business, and essentially, how accurate your understanding of its finances will be.

Whilst there is no one “best” way across the board, there is for ecommerce.

The most common bookkeeping methods

Cash accounting

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.

Only when money leaves your hands or arrives into them do you count the income or expense. This method allows you to easily understand your cash flow.

Accrual accounting

This 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.

What sellers need to do

Go with accrual accounting. A2X automatically organizes your books this way for you.

You get a better picture of the present and future of your cash flow. You can forecast more accurately, make more informed decisions about your finances and prepare for the peaks and troughs of your business finances. Read more about this here.

Cost of Goods Sold (COGS)

There are numerous elements of your finances that you need to keep track of. One of those is COGS.

Cost of goods sold is an important metric for ecommerce sellers.

“Cost of goods sold (COGS) refers to the direct costs of producing the goods sold by a company. This amount includes the cost of the materials and labor directly used to create the good. It excludes indirect expenses, such as distribution costs and sales force costs.

Cost of goods sold is also referred to as “cost of sales.""

- Investopedia.

To know whether your products are profitable, you need to know how much you paid to acquire and sell them in the first place.

Is your selling price leaving you with profit in the end?

Be careful not to confuse COGS with profit. It should be used to help you calculate your margin.

Item price - COGS = gross margin.

What sellers need to do

Keep track of your COGS. Most accounting software partners will do this for you when integrated with your ecommerce platform. A2X can also do this for you, too.

Gross Margins

Another key aspect of successful accounting is knowing, planning, and influencing your gross margins.

“Gross margin is a company’s net sales revenue minus its cost of goods sold (COGS).

In other words, it is the sales revenue a company retains after incurring the direct costs associated with producing the goods it sells, and the services it provides. The higher the gross margin, the more capital a company retains on each dollar of sales, which it can then use to pay other costs or satisfy debt obligations.”

- Investopedia.

According to many of our accounting partners, paying attention to expenses is something many of their clients don’t do well enough.

Without understanding the costs associated with selling, you can’t accurately calculate your margins. And without that, you can’t minimize the first to maximize the second.

Margins look different from seller to seller, and from product to product. In general, you want higher margins on slower-moving products.

What sellers need to do

Business owners use their gross margins to measure production costs against sales revenue.

By tracking this accurately, ecommerce sellers can adjust their sales strategies to maintain a steady margin.

Gross margin dollars can be funnelled into other areas of the business, like paying debts, admin costs or operational expenses.

Variable Expenses

Not all ecommerce costs are fixed, and these need to be properly prepared for.

“A variable cost is a corporate expense that changes in proportion to how much a company produces or sells. Examples of variable costs include a manufacturing company’s costs of raw materials and packaging—or a retail company’s credit card transaction fees or shipping expenses, which rise or fall with sales.”

- Investopedia.

When you hear the term ‘expense’, your mind may jump straight to costs like tax, interest, fees, and fixed costs - but what about the ones that change?

Variable costs work differently from fixed costs when calculated:

  • Fixed costs are simply added together to find a company’s total.
  • Variable costs must take more into account, as shown below:

Total variable costs = quantity of products produced x variable cost per unit.

A business with higher variable costs compared to fixed costs typically has more consistent profitability (though the profitability may not be high).

A business with lower variable costs than fixed costs will likely be more profitable once those fixed costs are covered.

What sellers need to do

Keep track of these costs, and look out for opportunities to renegotiate them - especially when production quantities increase.

By keeping these as low as possible, you can protect your margins.

Financial Statements: Profit and Loss (P&L)

Moving onto the financial reports ecommerce sellers need, we start with P&Ls.

Profit and loss (P&L) statements, or income statements, are standard business accounting reports.

These summarize revenue, expenses, and costs incurred in a particular period of time - usually a financial quarter or year.

They are used to show whether a business can generate profit based on its financial management and essentially helps you to compare your performance month-to-month and year-on-year.

What sellers need to do

Pick accounting software with this feature built-in (see more about this below), and use it to help you adjust your sales strategies.

What you want to see in your income statement:

  • That your sales and net income are both increasing, almost in parallel. If they aren’t, you should find the answer in your operating expenses.

Financial Statements: Balance Sheets

Balance sheets are another standard financial report that all businesses should have.

They show a snapshot at any point in time of what a company owns and is owed.

Three key things are tracked in a balance sheet: assets (anything you own, like inventory), liabilities (anything you owe, like loans or purchases), and equity (income, expenses, distributions, and retained earnings).

For every activity in a balance sheet there is an opposite reaction, hence the name “balance” sheet.

Your assets will always equal your liabilities + equity.

Balance sheets are like the world map, with P&L and cash flow statements as street view.

What sellers need to do

You want to minimize the assets it takes to get the maximum amount of revenue and ensure you can pay your debts.

These are the things that ecommerce sellers should be looking for when regularly reviewing their balance sheets:

  • Is your equity growing over time? And is there a trend? If you see sudden reductions, you need to investigate the cause.
  • Check out your current assets (ones due in a year or less). Check that against your current liabilities - can you cover what you owe? If not, you have some work to do.

For more information about using financial statements and how they relate to each other, check out this video.

Cloud Accounting Software

Finally, we talk about the systems that bring it all together.

Many ecommerce sellers start their accounting journeys with spreadsheets because they are free and seemingly easy.

But this is a mistake.

Spreadsheets are not scalable, they’re susceptible to human error, insecure, and limited.

Sellers need a true piece of accounting software. This should integrate with their platform and have functionality for the financial reports we discussed above.

If you want your business to become your full-time focus, accounting software should be top of your priority list.

What sellers need to do

Pick an accounting software partner that best suits their business needs. We recommend Sage, Xero, and Quickbooks for ecommerce sellers, as these have the tools and resources you need.

For help choosing yours, check out our accounting software guides below:

Starting Out the Right Way

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 ecommerce specialist accountant isn’t always possible straight away, but you still have options – it’s all about starting out strong.

You can find a trusted directory of specialist ecommerce accountants here, and our guide to finding your best fit here.

Bring It All Together With A2X

A2X brings together all of the accounting aspects discussed above to help you start strong with your books.

Integrating with your software and platform, A2X helps you understand every income and expense line in your bank deposits, your COGS, your monthly financial performance, and your margins.

Try A2X for free today.

Next in the Series…

This blog is the first in our ecommerce accounting fundamentals series.

From the core accounting concepts ecommerce sellers need to know about through to cash flow management, bookkeeping best practices and what software to use, we cover everything you need to know.

Next up: what makes ecommerce accounting unique and sometimes, much more challenging.