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Ecommerce Accounting Basics: Making Profits Online
Every financially successful online entrepreneur understands the eCommerce accounting basics – we cover 10 of them here. How many have you got in place?
So why should you learn about ecommerce accounting basics? Let’s face it; accounting is neither easy nor interesting when it comes to running a business. However, it plays a critical role in its success. As such, you have to choose between handling it yourself or find an expert to do it for you. If you choose to work with an expert, keep in mind that you still will have learn some of the basics to make better business and financial decisions.
In this article we cover the eCommerce accounting basics that you need to run your business successfully. Even if you choose to hire an accountant you need the basics at your fingertips, so you are able to tell what’s going on and ask critical questions. At the end of the day, it’s still your business and you want it to be successful. With that in mind, let’s start:
1. Implement accounting software
If you don’t want to struggle with an accounting-induced headache, you need to get accounting software appropriate for the level of business. Using Google sheets or Excel, whilst cheap, is very unlikely to give you the information necessary required to lodge tax returns or manage cashflow.
So, choose a wiser move and get good accounting software. There many great options such as Xero or Quickbooks. These integrate well with Shopify which also comes with a variety of accounting apps in their app market.
These platforms often come with free trial period so you can try each on your list of choices and pick the one that fits your business and expertise. Ensure the software you will get can track costs, inventory, and sales.
A lot of online software just focuses on a particular accounting role like providing reports (Pocketbook) or generating an invoice (Invoice Simple). Rather, you need an all in one package to avoid hassles during accounting and ensure it can sync directly with any e-commerce store or your store.
2. Keep track of cash flow
It’s very important to be mindful of cash flow and having this readily visible in your accounts. If you happen to be using a personal account as a business account, please reconsider as you are actually creating double the bookkeeping work. You need to have a separate bank account for your business. This way, you can keep tabs on how much revenue is being generated, and this is where tracking the cash flows of your business comes in handy.
Through cash flow, you can compare the amounts coming in versus the amount withdrawn from your business account. And as long as your account receives more than what’s going out, your business is likely to be performing okay (noting there are other matters like GST, super, PAYG Withholding and income tax to keep on top of also!).
Another critical factor to consider in cash flow is time. Ensure the cash flow coincides with the time you need to settle bills. This way, you can afford to settle your bills whether it’s employees’ salary or payment for another bulk shipment of inventory.
Meanwhile, take note of any delayed activity especially in payments. Do you have clients who often put a hold on paying invoices until they receive their product or services? This is important especially if you are targeting the payment to settle certain bills or spend.
To make your cashflow experience less bumpy, we recommend putting together a cashflow forecast on either monthly or weekly basis to anticipate any gaps in cash in advance. Be ensure the target amount you want to budget for expenses doesn’t surpass what you have in the account. How much of your spend is essential versus discretionary (e.g. PR)?
- Cashflow is essential for healthy business, so also consider the following:
- Avoid settling bills before the due date.
- Incorporate payment plans like a subscription or monthly payments to guarantee inflow of cash.
- Always have a business reserve account for emergencies (this should cover at least a month’s worth of expenses).
3. Inventory Count
Also known as a stocktake, regular inventory counts are important in running your eCommerce store. Through it, you can determine how much you need in stock to avoid ordering more than what’s necessary. You can avoid loss by identifying stock which isn’t turning over as well.
Further, inventory can be equated to locked up capital. The only way to release this capital is by selling the product. The money in form of inventory is also quite volatile since you may end up making more profits if there is a price increase in the product or a loss when it drops.
Lastly, look out for shrinkage. Shrinkage is the loss of inventory linked to factors such as employee theft, damage, admin error, vendor fraud, etc. It’s more common if you have an actual store. However, if you are running your business from a warehouse or drop shipping then eCommerce losses are lower and least when you are storing your products at home.
Of course, inventory count only applies if you are dealing with products.
4. Unravel the COGS (Cost of Goods Sold)
This refers to the expense of goods sold. In simple terms, it is the costs of inventory which is sold. This includes the cost of material, packaging, freight and labour used excluding indirect expenses like HubSpot and marketing.
Calculating this is relatively easy if you are dealing with products that have the same prices. However, it gets complicated if the same product has a different cost of production, labour, and packaging among other direct costs. However, you can get around this easily by employing a weighted average during calculations.
As you consider the labour of employees as part of the COGS, note that it can only be the case, if you are paying them per product they are assembling. This means if you are paying them on a flat rate daily even when they don’t assemble anything you should not include the cost of labour in the COGS. Payment processing fees for sales such as Stripe or Paypal fees should also feature as part of COGS.
But why do you need to understand COGS as part of ecommerce accounting basics? COGS is important when determining the gross margin – perhaps an even more important figure than turnover. But keep in mind; this is not your actual profit. It’s just the money from each product minus indirect expenses (like admin or sales). You can use accounting software such as Xero or Unleashed in tracking the COGS and avoid the complicated task of manually doing it.
5. Determine fixed vs variable costs
The next step in your ecommerce accounting basics course is to know the difference between fixed costs and variable costs.
Fixed Costs: These are expenses which don’t change based on production level or output. They include operating expenses like rent, property taxes, depreciation, research and development, marketing unrelated to revenue, administrative costs, computers, and software.
Variable Costs: These are expenses that vary depending on your business’s level of output or production. They include variable expenses such as raw materials, labour, payment processing fees, utilities, and sales commissions.
6. Determine the break-even sales you need
When it comes to running a successful business, strategic tasks like planning and budgeting are vital to keeping your business afloat. A key figure here is understanding your break even point. This refers to the number of sales you need to achieve to take care of your costs.
This means your sales should generate enough to cover the COGS plus operating expenses to break-even. At this point, there are no profits or losses.
As a formula this is represented as:
Break Even Volume (BEV) = fixed cost/revenue per unit minus variable cost per unit = operating costs/unit margin
Finally, you need to generate more from the sales to surpass the BEV. However, if your business is making less than break-even, your business is in trouble. At this point, you need strategies to make more by raising the prices of your products or services or perhaps lowering COGS.
7. Track your sales & profits before tax
Once you are through with determining the break-even and the minimum amount you have to generate from sales, the next step is tracking your sales. By doing this, you can predict whether you will be able to meet the break-even minimum amount through your sales.
One of the best ways to monitor your sales is using Google Analytics which can link with your eCommerce platform.
Once you have compiled COGS, sales, and fixed expenses, you can determine what you’ve made before income tax. However, things become a little complicated from this point and it’s best to seek the services of an ecommerce accounting firm like Fullstack. Outsourcing tax expertise is not only deductible but is a common procedure for basic business management.
8. Understand where tax fits in the picture or where to find help
Unfortunately, you cannot escape this piece and many entrepreneurs often whine due to taxes. Dealing with taxation is somewhat complicated and in most cases, you are advised to seek professional assistance especially if you are selling your products or services across the world. In Australia, eCommerce businesses are exposed to a suite of different taxes including
Income Tax – paid based on the taxable income declared from your annual income tax return and income activity statement.
Goods and Services Tax – tax levied on most Australian goods and services bought or purchased with notable exclusions like export sales or government services.
Pay as you Go Withholding Tax – tax withheld on behalf of your employees in respect of tax on their salary and wages.
The most common tax you’ll encounter is GST on sales for which your eCommerce platform can help you in a big way. Ensure the software you are using can calculate the tax payable for product sold. If you are dealing with tax-exempted products (such as fresh food), then ensure your clients are not taxed when buying your product.
9. Have in place a plan to cover your taxes
Of course tax has a place in considering ecommerce accounting basics. It is key that you include GST in the sale price on your products – in Australia this is 10% of price of the applicable good or service. To be on the safe side, ensure you set aside GST credits received regularly into a separate savings account when received from your customers.
By doing so, you can easily lodge and pay your Business Activity Statements (featuring GST payable) without hurting your business financially when due.
10. Master the balance sheet
The final step in ecommerce accounting basics is mastering the balance sheet, now that you have covered the cash flow and profit and loss. Through the balance sheet, you can keep track of your business financial position and overall health. That said, the profit and loss is a sneak peek while the balance sheet is the complete picture.
A balance sheet comprises equity, liabilities, and assets. The assets are items or things with value. It could be cash, inventory or accounts receivable (revenue payable by customers). Liabilities on the other hand are what you owe in debt or any other form such as credit card balances or bills outstanding. Equity on the other hand is the assets you remain with after settling the liabilities. Through the balance sheet, you can see whether your business is in a healthy or cash poor situation.
With the above ten eCommerce accounting basics in place, you can run your business comfortably. At the start it is key to getting the accounting software implemented correctly, which reduces multiple tasks which are otherwise quite complex to run manually.
Thereafter, you can monitor performance and track the growth of your business. In places like taxation where things might seem more complex, you can consider getting professional assistance from eCommerce accountants at Fullstack.
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Stuart Reynolds is the founder of Fullstack Advisory, an award-winning accounting firm for businesses leading the future. He is a 3rd generation accountant who specialises in tech companies, agencies and entrepreneurs.