Ecommerce accounting basics: The Principles to Ensure a Profitable Store

Running an ecommerce business takes more than great concepts, products, marketing, and inventory. It also requires an accounting system to follow the financials. What is your spending? What is your profit? Are you in line with your budget for your business? Do you have the approval of the government for your company? Ecommerce accounting employs well-known procedures to track your financial records and business transactions and keeping updated on taxes, payroll, and profits.

No matter if you're only starting your ecommerce store or you've been in the business for a while, and are realizing that you require help in tracking your company's financials, this accounting guide will assist you in getting going in the right direction.

The accounting software for eCommerce lets you judge the financial health of your business, and to make more precise financial projections when the business expands.

What is the ecommerce accounting process?

Businesses that are based on e-commerce are built upon transaction and inventory. The company makes profits. You deliver items. You buy and replenish inventory.
The basic principles of ecommerce accounting start with a method of keeping track of and reporting on your transactions, which includes purchase order, invoices, costs as well as taxes.

However, it is more than this. Accounting firms take that data and use it to prepare accounts so that they can examine and provide reports on the financial performance of your business.Ecommerce businesses also need particular attention to meet their fundamental business model.

Imagine what happens if you have a sale on your online shop. The customer will use their credit card to make payment to your payment processor. How do you know that sale affects your finances?

• The payment processor you used to make the transaction has received money, but it's not yet in your bank account as of yet.
• Sales tax is a cost, possibly from a different region or state
• Inventory declines
• Payment processor and credit card charges are incurred
• Actual income from the sale does not match the sale price.

Whatever the channel of sales the one sale can impact several areas of your financial record. The repercussions from this one transaction are likely to show up in your records of financial transactions in the coming months. In the event that your order is to get returned, many of these transactions must now be modified or reversed.

That's only one purchase.

Monitoring some of these is the job of a bookkeeper, and we'll go over the difference between accounting and bookkeeping for ecommerce a bit later.

In the beginning, we'll go over the basics of accounting terms.

Basic accounting terms

Here are the most important words to be aware of for accounting:

Transactions

A transaction happens any time cash is paid, received or requested by a vendor or business.

The term "transaction" can refer to any of the above:

• A business's owner can invest money into the company
• Sales revenue
• Invoices
• The expenses include salaries, marketing, travel, and construction expenses
• Assets purchased, such as offices, vehicles properties, materials, etc.

An individual transaction could have multiple components. If you are paying an hourly worker like this you must know the amount of time they were working, their net wages, tax deductions as well as their net earnings. Accounting software that is of the highest quality will be able to handle all the above tasks.

Transactions for ecommerce companies may be complicated due to particular factors, such as taxation and delays in timing due to the rift between consumer and business.

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

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

Credits and debits

All transactions are tracked by the system of debits and credits. First, let's define the most important terms:

Debit: A record of the amount debited from your bank account. You'll see debits show up on your account statement each time you make a purchase.

Credit Record of the amount that was added to your account.

Assets property (real or intellectual) held by an entity.

Liabilities are obligations that a company has to meet but are not yet fulfilled. A liability is a claim against the assets shown in a balance account.

Equity: The sum of assets after debits have been removed from them.

Let's consider how these terms contribute to what's called the main accounting equation:

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

A debit is added to the left of the equation as an asset. Credits are added on the right.As an example, if you make an offer of 500 dollars, the amount is debited from the assets of your company. It is also credited as owner's Equity in the form of revenue. When something is debited then something else has to be credited, because it helps to keep the balance.

That's a vastly simplified explanation, however it provides a good understanding of what the accounting software will be doing when you input transactions.

Cost of products sold (COGS)

Accounting for e-commerce must pay special consideration to the costs of the goods sold. It is all cost of selling a product, not counting things like payroll or marketing.

COGS covers all inventory costs that include purchasing, storing the inventory, managing it, and even shipping. Inventory is your largest expense when you're an e-commerce retailer, so if you don't have an accurate accounting picture of the costs of goods being sold, the margin of profit as well as your tax-deductible income could not be accurate.

An inaccurate COGS also makes it harder to know how much to invest in marketing, the prices you should be set, the amount of stock to purchase, whether you should hire employees, and the amount of warehouse space to acquire.

Profit margins

The margins represent the real income that your company earns when the sale is completed. Calculate margins using this equation:

    Margin = (Revenue + Cost of Goods) / Revenue  

In essence, it's the net profit you earn in a percentage. If you are able to sell 10,000 worth of goods within a week, and the COGS of the products you sell is $3000, your margins would be 70 percent.

Accounts receivable and accounts payable

The term "money" refers to cash that has not yet changed hands, yet is scheduled to.

Accounts receivable includes any money that is due to arrive on your account in the bank. For example, if you issue an invoice, that goes to accounts receivable until your recipient actually pays the invoice.

Accounts payable works the same way but reversed. When your company makes purchases from vendors when that vendor gives an order for purchase, it goes in the accounts payable account until you pay the vendor.

Ecommerce bookkeeping vs. accounting -- what's the difference?

There is some overlap between bookkeeping and the accounting. But in general, the distinction is that bookkeepers manage events, and accountants compile and analyse those events in order to create an accurate and useful overview of your business budget.

When a sporting analogy can help you understand the role of bookkeepers, they are the announcer of play-by-play, and accountants are like the analyst or color commentator. The bookkeeper tracks what happened. The accountant explains the meaning behind it.

What is an ecommerce bookkeeper do?

Tasks in bookkeeping are primarily focused on records, transactions as well as financial institutions. If you have employees, your bookkeeper is responsible for payroll. They also do things like:

• Invoice processing
• Send receipts
• Note what is in your business bank account and out of your business bank account
• Purchases of inventory records
• Consolidate your bank accounts each month
• Generate monthly financial statements
• Prepare year-end financial statements as well as tax documents

Accurate ecommerce bookkeeping will assist you to build a robust and solid business plan.

What exactly does an accountant for e-commerce do?

Ecommerce accountants will perform things like

• Track and analyze operational expenses as well as business performance
• Conduct financial forecasting
• Examine your financial statements- include those provided by your bookkeeper
• Plan your tax strategy, which includes making tax-deductible taxes
• Review the cash flow management

The objective of an accountant is to help ecommerce business owners make better financial choices.

Are you able to afford a new employee? Should you expand into a different country or state? What's the minimum you should be charging for your new product?

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

Accounting methods for ecommerce sellers

There are two primary ways of accounting for e-commerce -either the cash method or that of accrual. The approach of accrual is the more common one, and depending on the nature and size of your business, may be required by law.

The main difference between techniques is in the moment when the transaction is acknowledged.

Accounting on cash basis

In the cash basis accounting system, the transaction is deemed to have occurred when actual money has exchanged hands. When you pay an invoice, the cash basis accounting marks that as an expense. If you get an invoice in January but you pay it in March, the cash accounting records the invoice as an expense during March.

Income works the same way. Suppose you make a sale, and the customer signs to a plan of payment that will spread out their payment over a period of four months. Cash accounting allows you to consider this to be income every month when the cash comes in.

Accrual method accounting

When accounting for accrual, the transaction is recognized after the task is completed and an invoice has been sent. Suppose you place an order for a new paper for office in January. You then place it onto your company credit card. You receive the office paper immediately, but you don't actually pay for it until February, after which the credit card balances come in.

In accrual accounting, the transaction happens when you get the document. Take the receipt keep it in your file system, and then record the cost. It's an expense for January even though you don't pay for the item until February.

The same scenario applies to accrual accounting. accrual accounting will record the entire purchase price as an income at the time the transaction is completed, even though you won't actually get the entire amount until the end of four months.

Which method of accounting is best to use for companies that deal in e-commerce?

Accrual accounting gives you an easier understanding of the cost of goods sold each month. If you buy paper in August, the paper you purchased was part of the cost of running your business -it was in August and not until you arrive at paying the cost. If you sell something in May, then you sold the item during May, not July when the customer finally pays the bill.

It also works better in conjunction with managing inventory.

If you have $30,000 worth of purchase of inventory in September. Then, you decide to will sell the inventory over the following four months before the Christmas season. If you use cash accounting, you would mark the entire acquisition of inventory as an expense in September. If you use accrual accounting, you would mark it as an expense as you sell the item.

With the cash approach that you'd face a significant expense in September followed by artificially high profit margins in the months of October, November and December, because it will appear as if you have no expenses for the sale of your products.

Accrual accounting lets you reconcile the costs of doing business every month, and you will know which months produced the highest profit margins.

Three financial statements that are the primary ones

However, if you do decide to contract out your ecommerce accounting and bookkeeping services, you'll have to know how to understand and comprehend the financial statements. If you're doing it by yourself, using an ecommerce bookkeeping software to enter the transaction details will help you to prepare the three most important financial statements which include income statements (also called the "profit and loss statement" (also known as P&L), balance sheets, and cash flow statements.

Statement of income

An income statement shows the amount of profit that was earned over a specified period of time like one month. The profit people refer to when they use the term "bottom line." The profit you earn is the net amount you earn. If you've lost funds during the time, your net loss.

Balance sheet

Balance sheets report your assets, liabilities, and equity at a particular period of time, which is typically at the close of the quarter, month, or even a year. It's a snapshot of your financial situation.

Assets are items owned by a person which have worth. Accounts payable, also known as liabilities, are things you owe.

If you look back at the fundamental accounting equation that was discussed earlier, you'll see that equity simply is the sum of both liabilities and assets. Take away liabilities, and you'll have the "book value," also known as equity, the business you run.

Cash flow statement

The cash flow statement provides information on how your cash is changing during a given time period.

Each of the three reports are easily generated by your accounting software, so long as you've taken care to enter your financial details. If you don't have time for that, this is the perfect time to employ an ecommerce bookkeeper.

The most important financial metrics to use for eCommerce accounting

Taxjar published an amazing piece about ecommerce accounting metrics. It's important to remember that accounting isn't only concerned with keeping records of financial transactions. Accounting also tells the story about the financial status and the progress, or decrease of your online business.

These are the most important accounting metrics:

Revenue

Revenue refers to your gross receipts, before any expenses have been taken out. Revenue can be fairly simple to monitor. But by itself this gives an incomplete view.

Contribution margin

The selling price is plus the costs to sell this product. It's similar to the COGS number from earlier however, it is for every single item you offer. This figure does not take into account operating expenses.

Profit

Profit is what results after you have removed all your expenses from your revenue that includes marketing and operational expenses. If you have a high revenue but the profits are a bit low it is either time to boost revenue or cut costs.

Rate of conversion for Ecommerce

This is the percentage of customers who visit your online store who buy something.

Cost of acquisition for the customer

It typically costs a lot less to make extra sales to your current clients than it does to find an entirely new client.

If your CAC is extremely high and you're not willing to stop any of your marketing, you have two choices:

1. You can improve or enhance your marketing
2. Get started marketing to more of your existing customers

Customer lifetime value

If you're only a new ecommerce seller, you'll have difficulty in determining the right amount for your initial few years. However, with a good accounting program, you'll be able to start estimating this with time.

This amount helps justify your marketing expenses. Also, if you have a high CAC, yet your customer's lifetime value is significantly more, it's still worthwhile to spend the money to get these customers.

Average order value

Especially for newer ecommerce businesses This is an even superior metric over life-time value. If you pay 10 dollars to acquire a client however they'll spend around $25 on an average order, that's a good deal as long as your other expenses aren't expensive. If you can scale that up as you reach more clients, then you'll have a great time.

Cart abandonment rate

The number of people who buy this is alarmingly high in the case of e-commerce sites. According to TaxJar's sources approximately 70% of shoppers who shop online put products in carts but do not purchase them.

The most effective method for cutting down on abandonment of your cart is to email abandoned cart email messages, which can be automated with the right email platform, for example, MailPoet.

If you could lower the abandonment rates of carts to 60 or 50%, that will produce significant revenue growth. All it takes is a couple of automated emails then it's no problem.

Rates for refunds and returns to customers

Do a lot of customers return products for a refund? That's an indicator that something's wrong. Make sure you keep track of the situation and do your best to keep it low.

Five essential ecommerce accounting issues to take on

If you're at the beginning phases of being an e-commerce business owner, you need to be able to handle your basic accounting tasks soon so you don't end with hot water in the future. To be clear, 'hot water' can mean a lot of items, like:

• Taxes not paidsuch as income tax, sales tax, or state and local taxes
• False tax returns
• Inappropriate spending on inventories
• Employers you cannot afford to hire
• Insufficiently withdrawing equity

Below are a few ways to get your online accounting system off to a good start:

1. Set up a business bank account

The owners of small-sized businesses in the ecommerce sector tend to forget about this as they're busy with many other startup business activities.

But business accounting becomes very complicated when you mix the personal and business aspects. The business account is the one you use to pay for your business expenditures as well as the place where you'll pay your earnings from sales.

To open a business bank account, you'll need a Tax ID for your business.

2. Be prepared for your employees and contractors.

If you plan to have employees, you'll have create procedures for withholding taxes. Even if you plan to manage the company on your own for now, you'll probably still employ contractors on specific projects. Contractors paid more than an amount each year in the U.S. must be sent a 1099, so be sure to:

• Keep track of who you've paid and how much you've paid to them.
• Get a W-9 form from every contractor
• Keep current addresses on file for all employees you have

3. Get the accounting software you need.

If you expect to have hundreds or even thousands of transactions each month, you'll want accounting software like QuickBooks Online, Xero, or FreshBooks. Smaller businesses can get away with using the Excel spreadsheet, but a high-transaction business won't have the capacity to keep up with manual entries.

The Ecommerce Accounting Software automates the majority of the accounting essential tasks and makes your life easier. It stores, records, and retrieves financial data and uses it to produce financial reports and statements.

4. Keep all receipts, invoices and records of payments

The Reliability Principle of Accounting states that only transactions supported by documents should be documented. If you don't have records of an activity and you're not able to count it as income or an expense. If you attempted to claim a tax deduction for an expense you have no documentation of the amount you made payment for, it could be called tax fraud.

Maintain receipts in physical form. Or take photos of them and keep them in a digital format. Save all receipts and invoices in a separate folder for emails, not just your general email inbox.

5. Pay attention to the tax laws

Tax requirements vary dramatically depending on the kind of business and the location in which it is operating. It is important to be aware of taxes on sales, import tax if you are involved in overseas transactions. Tax withholding taxes for the quarter, as well as other taxes specific to your nation, state or province, city or region.

The tax will be incorporated into your accounting software and financial reports. Always seek out a tax expert in order to be sure that you're following right procedures.There's a lot more to talk about tax administration. There are two major tax issues you'll have to deal with:

Taxes on sales and trackers

Ecommerce sales taxes have become very complicated. In fact, nearly every US state now charges an online sales tax, and the EU has also a sales tax system.

In the U.S., each state is charged at different rates and has different requirements for how sales tax should be applied.

Taxes on business that are estimated to be paid quarterly

Pre-tax business earnings are tax-free. Like a typical 1099-employee, your ecommerce business makes cash before tax has been paid on that income.

And like a 1099 employee, you need to pay quarterly income taxes. If you don't tax, the government could punish you for not paying on your tax bill.

What can you do to manage this? The idea is to avoid falling way behind on your tax obligations. The most effective method to control quarterly taxes is to set an amount of your monthly income which you can use to pay taxes estimated each quarter.

Your accounting software can easily handle all this as well as the tax obligations for sales. And speaking of software...

What are the reasons why your online business requires accounting software

Take the time to think about this and ensure you understand the benefits of making use of software that can help you manage the accounting and e-commerce tasks.

First, as you've just seen, tax management has become extremely challenging in recent years, particularly with regards to the tax on sales and revenues from multiple sales channels. If you run an online business that sells products across the US or in a large variety of states, then you'll not enjoy trying to handle everything on your own. You have a business to run.

The software also handles your quarterly tax allocation, which you'll need to pay taxes on your income and assist in the filing your tax year-end statements. If you're also being subject to local or state taxes, that complexity mounts to a higher degree. A good accounting program can handle all of these requirements.

Second, accounting software makes it much easier to track your income and expenses by generating financial statements so you know the margin of your profit per month and can see your business capital.

Third, accounting software helps control payrolls, which includes contractors. If you're not looking to pay for bookskeeping or accounting for your online business it is a must to have accounting software.

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

If you're not using accounting software, or you decide to purchase it, however don't wish to be responsible for using it, you'll need a bookkeeper. As your company grows, you'll eventually also need to consider some of the accounting firms available that understand the nuances of online businesses.

A lot of business owners who run e-commerce like the idea that they can run their own show, including acting as the Chief Financial Officer. And so long as their business remains small, you might be able to get away in this way. But let's define "small."

With an ecommerce company making up to $100,000 or more each year in net income, that's already going to start getting way out of control in terms of your accounting system If you're selling your products across several states or nations. The sales taxes alone just get too complex.

Additionally, you must deal in return shipping as well as chargebacks and the rest. Most ecommerce platforms sell lower-priced items, and operate in bulk. Except for the rare exclusion, it implies you'll be dealing with many transactions.

The greater the number of transactions, the longer it will take to keep track of the entire process. And even the most "small" eCommerce business earning less than $100,000 of net income per year selling products priced between $5 and $20 will have a lot of transactions.

If your company is only selling in a single region or state, province or nation, your degree of tax complexity is way lower. In that scenario, you might be able to do the tax yourself if you want the extra job.

You can test your preferred method to see how it performs. You are able to alter your mind in the future.

has accounting covered

is aware of the responsibilities business owners have each day. Manually inputting transactions and creating accounting reports can be very tedious and tax planning can cause you to be overwhelmed Accounting is an essential part of running a successful business.