Ecommerce Accounting Basics: The Principles to run a successful store

Running an ecommerce business takes more than great concepts and products, but also marketing and inventory. It also requires an accounting system that can track the money. What is your spending? What is your profit? Are you in line with your budget for your business? Is the government happy with your business? Ecommerce accounting employs well-known procedures to keep track of your financial records and business transactions. It also keeps you current on tax laws as well as payroll and profit.

If you're starting your online store, or you've been operating for a little while and you realize that need help tracking your business finances, this ecommerce accounting guide will get you moving in the right direction.

Accounting for E-commerce allows you to evaluate the financial condition of your company and create better financial forecasts as your business grows.

What does ecommerce accounting involve?

Ecommerce businesses are built on the transactions that happen and also inventory. It is where you make the sales. You distribute items. You buy and replenish inventory.
The basic principles of ecommerce accounting begin with the system of keeping track of and reporting on your transactions. This includes purchases order, invoices, costs and taxation.

It goes further beyond this. Accounting firms analyze the information and then use the information to create accounts so that they are able to evaluate and present the financial performance of your business.Ecommerce firms also need specialized attention due to the fundamentals of the business model.

Consider what happens if you sell a product in your ecommerce store. The customer will use their credit card to make payment to your payment processor. Which are the different ways the sale impacts your financials?

• Your payment processor has gotten money, but it's not yet in your bank account as of yet.
• Sales taxes are incurred 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 is different from the price of sale

No matter the sales channel the mere fact of a sale touches on many aspects of your financial records -- and the aftereffects of the sale be recorded in your records of financial transactions over the next couple months. And if the order does be returned, the majority of these transactions will need to be reversed or modified.

And, that's just one deal.

The tracking of some of this is the task of the bookkeeper. we'll discuss the distinctions between accounting and bookkeeping for e-commerce a bit later.

First, let's begin with some accounting basics.

The basics of accounting

Here are the key terms to know for ecommerce accounting:

Transactions

A transaction occurs when money is spent, received, or asked from a company or a vendor.

An transaction can be one of the below:

• Money the business owner invests in the business
• Revenue from sales
• Invoices
• The expenses include salaries, marketing, travel, and construction expenses
• The assets purchased include vehicles, office equipment properties, materials, etc.

An individual transaction could contain multiple parts. When you pay an hourly worker such as a salesperson it is important to determine the length of time they were working, their gross wages, tax deductions and their net pay. The best accounting software can perform all of the above tasks.

Transactions for ecommerce companies may be complicated due to certain factors, particularly the tax on sales and timing issues caused by the separation between consumer and business.

Do you, for instance, charge sales tax right when you purchasing? If so, what happens to that cash if your product is returned after a month?

Accounting for Ecommerce aims to control the processes and transactions so that the aforementioned issues do not impair the financial performance of your company.

Debits and credits

All transactions are tracked by the system of debits and credits. Let's first define certain key terms:

Debit The record of the money that was taken out of your account. It will appear on your bank statement whenever you purchase.

Credit: A record of the amount that was added to your account.

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

Liabilities Liabilities: obligations of a business that are not yet fulfilled. The term "liability" refers to a claim against assets that are listed in a balance sheet.

Equity Amount of assets after debits are subtracted from them.

Now, we can examine how these concepts play into what's known as the accounting principal equation

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

A debit is added to the left of the equation as an asset. Credits are added to the right.As a simple example, if you make a sale for $500, that $500 gets debited and added to the assets of your company. It is also credit as owner's Equity through earnings. If something is deducted and credited, another item must also 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 does when you record transactions.

Cost of products sold (COGS)

Ecommerce accounting must pay particular consideration to the costs of goods sold. This refers to all the expenses required for selling the product, which does not include items like marketing or payroll.

COGS covers all inventory costs that include storage, purchasing the inventory, handling, and shipping. The cost of inventory is one of the largest expenses when you're an e-commerce retailer If you don't have a clear accounting overview of the expenses of products sold, your profits margins and tax-deductible income could be skewed.

An inaccurate COGS also makes difficult to determine what to spend on marketing, the prices you should determine, what quantity of inventory to order, if you should hire employees, and the amount of warehouse space you need to purchase.

Profit margins

Margins represent the actual income your business acquires after the sale is completed. The way to calculate margins is this formula:

    Margin is (Revenue - Cost of Goods) Revenue  

In essence, it's your net profits expressed in percentage. If you are able to sell $10,000 worth of products in a week and your COGS on those products is $3000, your margins would be 70%.

Receivables and accounts payables

The terms are used to describe money which hasn't yet changed hands, yet is scheduled to.

Accounts receivable includes any money that's due on your account in the bank. As an example, if for example you send out an invoice, that goes to accounts receivable until your recipient actually pays the invoice.

Accounts payable works the same as it does but reversed. When your company makes an order with a vendor when that vendor gives the buyer a purchase request, it goes in the accounts payable account until you make the payment.

Ecommerce accounting vs bookkeeping -- what's the distinction?

There's a bit of overlap between bookkeeping and financial accounting. However, the main distinction is that bookkeepers manage certain events, while accountants collect and analyze those events in order to provide a precise and useful picture of your business budget.

If a sports analogy helps to understand, bookkeepers are similar to the play-by-play announcer, and accountants are like an analyst or color commentary. The bookkeeper tracks what happened. The accountant tells you the meaning behind it.

What does an ecommerce bookkeeper do?

The bookkeeping duties focus on records, transactions and banks and financial institutions. If you have employees the bookkeeper handles the payroll. The bookkeeper also handles things such as:

• Processing invoices
• Send receipts
• Keep track of what goes in and goes out from your business bank account
• Record inventory purchases
• Check your bank account reconciliation every month
• Create monthly financial statements
• Create year-end statements and tax documents

An accurate bookkeeping for your online business can aid you in creating a solid and stable business model.

What is an ecommerce accountant supposed to do?

An ecommerce accountant will do things like

• Analyze and track operational costs and business performance
• Conduct financial forecasting
• Review your financial statements, including those from your bookkeeper
• Perform tax planning, including filing returns
• Report on the management of your cash flow

The objective of an accountant is to assist e-commerce business owners make sound financial choices.

Are you able to afford new employees? Do you need to expand into a new state or country? What is the minimum amount you can cost for new products?

Ecommerce accounting in its most efficient form can be used to address these issues.

The accounting methods used by e-commerce sellers

There are two primary techniques of online accounting- the cash method and that of accrual. The method of accrual is the most frequent one, and based on the nature and size of your business, may be required by law.

The main difference between ways of recognizing transactions is the way in which a transaction is recognized.

Accounting for cash basis

In cash basis accounting, an event is deemed to have occurred when the actual amount of money been transferred. When you pay an invoice, the cash basis accounting makes it an expense. If you get an invoice from January and you pay it in March, then cash accounting shows it as an expense in March.

The way that income works is the same. When you have a sale that is followed by a client signing to sign up for a monthly payment plan which spreads the payment over a period of 4 months. In cash accounting, you take this income as a monthly one each month that money is received.

Accrual method of accounting

When accounting for accrual, the transaction is recognized after the task has been completed and the invoice sent. Suppose you place an order for a fresh office supply in January. You then place it onto your company credit card. Office paper arrives instantly, however you do not actually purchase it until February, when your statements on your credit card balances are received.

When accounting for accrual it is when you get the document. The receipt is taken, store it in your file system, and then record the cost. It's an expense for January even if you don't pay for it until February.

Using the same example, accrual accounting records the entire purchase price as income on the day that the transaction is completed, even though you won't actually receive all the money until after four months.

Which accounting method is better for ecommerce businesses?

Accrual accounting provides you with a clearer picture of your expenses for selling your goods every month. If you buy paper in August, it is part of the price operating your businessbut in August, not until you arrive at paying the cost. If you make a sale in May, then it was a sale that occurred in May, not in July when the customer finally sends the money.

Additionally, it is more effective in conjunction with managing inventory.

Suppose you make $30,000 in new inventory purchases in September when you decide to sell the inventory over the next four months before the holiday season. Cash accounting is where you'd mark your entire inventory purchase as an expense for the month of September. If you are using accrual accounting, you'd declare it an expense as you sell the product.

If you were to use the cash method, you'd have a big cost in September and then artificially high profit margins in October, November, and December, because it will appear like you don't have cost of selling goods.

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

Three financial statements that are the primary ones

If you are planning outsourcing your accounting for e-commerce and bookkeeping services, you'll have to be able to understand and comprehend the financial reports. If you're doing this yourself, utilizing your ecommerce bookkeeping software for logging transaction information will enable you to prepare the three financial statements that are essential to preparing which include income statements (also called the "profit and loss report" also known as P&L), balance sheets, as well as cash flow statements.

Income statement

An income statement reports profit earned over the specified time period for example, one month. The profit people mean when they employ the term "bottom line." Profit is your net income. If you've lost cash during that period then 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 a month, quarter, or year. They provide a picture of your financial health.

Assets are things owned which have value. Accounts payable, also known as liabilities are debts you have to pay.

If you go back to the fundamental accounting equation that was discussed earlier, you'll see that equity is essentially the sum of the liabilities and assets. Subtract liabilities from assets, and you'll have the "book value," also known as equity, your company.

Statement of cash flow

The statement of cash flows provides on how your cash in your account has changed over the specified time.

Each of the three reports can be produced quickly by your accounting software, so long as you've been diligent about entering the correct financial information. If you're busy to do that, it's the perfect time to employ an ecommerce bookkeeper.

The most important financial metrics to use for eCommerce accounting

TaxJar released an amazing article regarding ecommerce accounting metrics. Be aware that accounting isn't just recording financial data. Accounting can also inform you of the financial condition as well as the expansion (or decline) of your online business.

Below are their most crucial accounting parameters:

Revenue

Revenue is your total earnings before costs have been taken out. It is relatively simple to monitor. However, by itself it provides an incomplete view.

Margin for contribution

The selling price is plus the costs to sell that product. It is sort of like the COGS figures from the past but it applies to each product you sell. It does not include operational expenses.

Profit

Profit comes from the results that occur after you take away all your expenses from your revenue, including marketing and operating expenses. If you have a high revenue but your profits are low, you either need to boost revenue or cut costs.

Ecommerce conversion rate

This is the percentage of visitors to your ecommerce shop who purchase something.

Customer acquisition cost

Typically, it costs a lot less to make additional sales to your existing clients than it does to find a new customer.

So, if your CAC is high, and you're not willing to stop your advertising, you've got two options:

1. Make an effort to enhance or improve your marketing
2. Begin to market more effectively to existing customers

Customer lifetime value

If you're only a new ecommerce seller, you'll have difficult time making this decision for the beginning years. With a good accounting system it will be possible to estimate this amount in the future.

This amount helps to justify the cost of your advertising. If, for instance, your CAC is very high however, your lifetime value of the customer is more, it's still worth the cost to acquire those clients.

Average order value

Particularly for smaller e-commerce companies It's a much better metric to use than the lifetime value. If you spend 10 dollars to acquire a client, but they spend around $25 on an average order, that's a good deal, provided that your other expenses aren't too high. If you're able to ramp 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 for online stores. Based on TaxJar, about 70% of online shoppers put products in carts however they don't purchase them.

The most effective method to reduce abandonment rates is to mail abandoned cart emails, which is easy to automate with the right email platform, for example, EmailPoet.

If you could lower the abandonment rate to 50% or 60% percent, you will see a sizable increase in revenue. And if all it takes is a couple of automated emails then it's no problem.

Return and refund rates for customers

Do a lot of customers return products for a refund? This is a sign that something is going wrong. Keep track of this and take every step you can to reduce it.

Five essential ecommerce accounting tasks to take on

If you're still in the initial phases of being an e-commerce business owner, you must to be able to handle the basics of accounting now so you don't end with hot water in the future. And just so we're clear"hot water" could mean many different things, including:

• Unpaid taxes -- sales tax, tax on income or local and state taxes
• Tax filings that are not correct
• Inappropriate spending on inventory
• Hiring employees you can't afford
• Withdrawing too much equity

These are steps you can take to get your online accounting system off to a good starting point:

1. Establish a separate bank for business account

Small-scale business owners of Ecommerce tend to forget about this as they're busy with their other startup tasks.

But business accounting becomes very challenging if you're combining the personal and business aspects. Your business account is what you use to pay for your business expenditures It's also where you'll deposit income from sales.

For opening a bank for business account, you'll need a Tax ID for your business.

2. Make sure you are prepared for contractors and employees.

If you're planning to employ employees, you'll have establish procedures to collect withholding tax. If you decide to manage the business entirely on your own there's a chance that you'll still need to employ contractors on specific assignments. Contractors paid more than an amount each year in the U.S. must be sent a 1099, so be certain to

• Keep track of who you've paid and the amount you've given them
• Request a form W-9 from each contractor
• Maintain current addresses for every person you employ

3. Get accounting software

If you plan to handle hundreds or thousands of transactions each month, you'll need accounting software such as QuickBooks Online, Xero, or FreshBooks. Companies with less transactions may get away with using the Excel spreadsheet, but a high-transaction business won't be able to keep pace by manually entering data.

Ecommerce accounting software automates most of the essential accounting tasks and simplifies your life. It stores, records, and retrieves data from financial records as well as produces financial reports and statements.

4. Make sure to keep all receipts, invoices as well as payment records

The Reliability Principle of Accounting says that transactions that have supporting documents should be documented. If there aren't any records of an activity that you don't have documentation for, it's not able to be counted as income or expense. If you attempt to claim tax benefits in the case of an expense for which you have no documentation of the amount you paid for, that could be considered tax evasion.

Save receipts that are physical. Take photos and save them electronically. Make sure to keep all receipts and invoices in a separate email folder too and not only your regular inbox.

5. Start paying attention to tax requirements

Tax requirements vary dramatically depending on the kind of business and where it operates. It is important to be aware of the compliance of sales tax as well as import taxes if you are involved in international transactions, tax withholding quarterly taxation, and other taxes specific to your nation, state, province, city, or region.

Those taxes will figure into the accounting software you use and your financial reports. It's always advisable to consult with a tax professional to ensure you're following the correct procedures.There's plenty more to discuss ecommerce tax administration. There are two major tax issues you'll have to tackle:

Tracking and paying sales taxes

Ecommerce sales taxes have turned out to be extremely complex. Nearly every US state now charges online sales taxes as well as the EU also has a sales tax system.

In the U.S., each state charges different rates, and also has its own set of rules for when sales tax applies.

The payment of estimated quarterly business tax

Pre-tax business earnings are tax-free. Like a typical 1099-employee, your ecommerce business makes cash before tax is due on the income.

And like a 1099 employee, you need to pay your quarterly income tax. If you do not, the government will penalize you for being late on your tax bill.

How can you handle this? It is important to stay clear of being a long way behind with the tax bill. The most effective method to control quarterly taxes is to set the amount you will pay from your income each month and then use that to pay estimated taxes every quarter.

Accounting software is able to handle all this as well as taxes on sales. And speaking of software...

Why your ecommerce business needs accounting software

It's worth some moment to rethink this issue and ensure you understand that there are advantages to making use of software that can help you manage your ecommerce accounting tasks.

As you've discovered, tax management has been extremely challenging particularly the tax on sales and revenues from different sales channels. If you run an online business that is selling products in the US or across a vast variety of states, then you'll be unable to keep up with this all on your own. Your business is yours to run.

The software also handles your quarterly tax allocation, which that you'll have to pay for tax on income, and help speed up preparation of your year-end tax statement. If you're also subject to state and local taxes, the complexity increases further. A good accounting program is able to meet all these requirements.

The second is that accounting software makes it much easier to monitor your earnings and expenditures by creating financial statements, to ensure you are aware of your margin for profit each month, and are able to see your company's equity.

Thirdly, accounting software can help manage payroll, including employees on contract. If you do not want to pay for ecommerce bookkeeping or accounting, then 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 an accounting system, or you do get it but don't want to be responsible for using it, you'll need to hire a bookkeeper. But as your business grows, you'll eventually also need to research the accounting firms available that understand the nuances of ecommerce businesses.

Some business owners in the ecommerce industry like the idea of running their own show, including acting as the Chief Financial Officer. so long as their business remains small, you might have the ability to do it in this way. But let's define "small."

With an ecommerce company making up to $100,000 or more each year in net income this is already likely become 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 become too complicated.

There is also the issue of dealing with returns, shipping, chargebacks, and all the other stuff. The majority of e-commerce platforms offer lower priced products, and deal in volume. Unless yours is an exception to that, that means you will have a lot of transactions.

More transactions mean more time it takes to keep track of everything. Even an "small" ecommerce business making only $100,000 net profit annually selling goods that range from $5 to $20 is likely to have lots of transactions.

Now, if your business is only selling in a single region, state, province, or nation, the degree of tax complexity goes way down. If that's the case, you might be able to do this yourself, if you want the extra work.

Try out your preference to see how it performs. You are able to alter your mind later.

Has accounting been covered

understands the responsibility every day business owners face. Manually inputting transactions and creating financial reports can be time consuming and tax planning may give you a headache, but accounting is essential to running a successful business.