Ecommerce Accounting Basics: Principles for a successful Store

The running of an online business requires more than just great ideas as well as products, marketing and inventory. You also need an ecommerce accounting system that can track the money. How much do you spend? What is your profit? Are you within your anticipated budget for your business? Is the government happy with the business you run? Ecommerce accounting uses well-known processes to keep track of the financial information of your business and transactions and keeping current on tax laws, payroll, and profits.

No matter if you're only creating your first e-commerce store or you've been in the business for a little while and realize that you need help tracking your business finances, this ecommerce accounting guide will get you going in the right direction.

Accounting for Ecommerce allows you to judge the financial health of your business and make more accurate financial projections as your business grows.

What are the implications of ecommerce accounting?

Ecommerce businesses are built on transactions and inventory. It is where you make profits. You deliver goods. You buy and replenish inventory.
The basics of ecommerce accounting begin with a system for tracking and reporting transactions, which includes purchase bills, orders, expense, and taxes.

But it goes much further beyond that. Accounting firms then will utilize the data they collect and it to produce financial statements that allow them to evaluate and present the financial performance of your business.Ecommerce businesses also need special attention because of the basic principles of the business model.

Imagine what happens if you make a sale in your online store. That means the customer uses their credit card and submits money to the processor that you use for payments. How do you know that sale affects your finances?

• Your payment processor has been paid, however it's not 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
• Payment processor and credit card costs are added to the charges
• The revenue from sale is different from the price of sale

Whichever sales channel you choose any one sale can impact many areas of your financial record. The repercussions from the sale will show up on your financial statements over the next couple months. And if the order does be returned, a lot of the transactions that were made must be modified or reversed.

And that's just one sale.

The tracking of some of this is the task of a bookkeeper, and we'll go over the difference between ecommerce bookkeeping and accounting some time later.

First, let's begin with some basic accounting terminology.

Accounting basics

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

Transactions

In accounting terminology, a transaction is when money is transferred, spent, or asked for by a vendor or business.

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

• Money the business owner invests in the business
• Revenue from sales
• Invoices
• Expenses like the cost of wages, marketing, travel, and construction costs
• The assets purchased include offices, vehicles, property, or materials

An individual transaction could comprise multiple elements. If you are paying an hourly employee such as a salesperson you must know the amount of time they were working, their gross wages, tax deductions, and net pay. Accounting software that is of the highest quality is able to perform these tasks.

Transactions for ecommerce companies are often complicated because of certain factors, particularly sales taxes and timing delays caused by the separation between business and consumer.

As an example, would you charge sales tax right on the day of purchasing? If yes What happens to the cash if your product is returned a month later?

Ecommerce accounting attempts to manage your transactions and processes so these sorts of complications don't affect the financial outlook of your business.

Debits and credits

Each transaction is monitored by the system of debits and credits. First, let's define some key terms:

Debit A document of the money taken from your bank account. The debits will show on your statement when you buy something.

Credit An account of the funds that was deposited into your account.

Assets: Property (real or intellectual) that is owned by an organisation.

Liabilities Liabilities: obligations of a business that have yet to be fulfilled. Liabilities are claims against assets that are listed on the balance report.

Equity is the sum of assets after debits were taken out of them.

Now, we can look at how these terms play into what's known as the primary accounting equation

    assets = liabilities + equity (Owner's or the Corporation's)  

A debit is added on 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 dollars, the amount is debited, and then added to your assets in the business. It is also added to the owner's Equity as income. When something is debited, something else must be added, as it keeps the math balanced.

This is a simplified explanation that gives you a basic idea of what your accounting program is doing when you enter transactions.

Cost of products sold (COGS)

Accounting for e-commerce must pay special consideration to the costs of the goods sold. This refers to all the cost of selling products, and not just things like payroll or marketing.

COGS covers all inventory costs, including purchasing, storing as well as managing the shipping. The cost of inventory is one of the largest expenses as an ecommerce seller, so if you don't have an accurate accounting picture of the expenses of products being sold, the margin of profit and taxable income will also not be accurate.

Incorrect COGS makes difficult to determine the amount to budget for marketing, which prices to set, how much inventory to order, if it is necessary to hire employees as well as how much warehouse space to acquire.

Profit margins

The margins represent the real income your business acquires after an offer has been accepted. Calculate margins using this formula:

    Margin is (Revenue + Cost of Goods) / Revenue  

In essence, it's the net profit you earn in a percentage. If you're selling $10,000 worth of products in a week and your COGS on these products is $3000 your margin would be 70%.

Repayable accounts and accounts receivable

These are terms used to describe money that has not yet changed hands, however it is planned to.

The term "accounts receivable" refers to any amount that is due to arrive into your bank account. In the case of an example, for instance, if you send out an invoice, the money is placed into accounts receivable till the client actually makes payment to the invoice.

Accounts payable works the same way but reversed. If you make a purchase from a vendor, and that vendor sends you a purchase order, it goes in the accounts payable account until you complete the transaction.

Ecommerce bookkeeping vs. accounting -What's the different?

There's some overlap between ecommerce bookkeeping and accounting. In general, however, the difference is that bookkeepers process events, and accountants compile the data and then analyze it in order to provide a precise and useful picture of your business budget.

In the event that a sport analogy aids you understand the role of bookkeepers, they are the announcer for play-by-play games accounting professionals are similar to the color or analyst. The bookkeeper keeps track of what occurred. Accounting professionals explain what it means.

What exactly does an Ecommerce Bookkeeper do?

Bookkeeping tasks focus primarily on transactions, records as well as financial institutions. If you employ employees, your bookkeeper is responsible for payroll. They can also handle things like:

• Process invoices
• Send receipts
• Note what is in your business bank account and what goes out of the business bank account
• Record purchases of inventory
• Consolidate your bank accounts each month
• Produce monthly financial statements
• Prepare year-end financial statements as well as tax documents

An accurate bookkeeping for your online business can help you build a financially robust and solid business plan.

What is an accountant who specializes in ecommerce? accomplish?

An ecommerce accountant will do things like

• Track and analyze operational expenses and performance of the business
• Conduct financial forecasting
• Examine your financial statements- include those provided by your bookkeeper
• Perform tax planning, including the filing of tax returns
• Report on the management of your cash flow

The goal of the accountant is to aid ecommerce company owners make better financial choices.

Are you able to afford an employee who isn't yours? Should you expand into a new state or country? What's the minimum you should charge for a new product?

Ecommerce accounting that is at its finest will be able to address these questions.

Methods of accounting for sellers selling e-commerce

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

The primary difference between techniques is in the moment when an event is detected.

Accounting on cash basis

In the cash basis accounting system, a transaction is recognized when cash has actually been transferred. If you make a payment on an invoice, the cash basis accounting marks that as an expense. If you receive an invoice in January, but you pay it off in March, the cash accounting records it as a charge in March.

Income operates the same way. If you sell something when a customer signs to a plan of payment that will spread out the payments across four months. Cash accounting allows you to consider this to be income every month the money comes in.

Accrual method accounting

When accounting for accrual transactions, a transaction is deemed to be completed when the work was completed and the invoice sent. Suppose you place an order for fresh paper for office in January, and then put it on your corporate credit card. Office paper arrives immediately, but you do not actually purchase the paper until February when your statements on your credit card account arrive.

For accrual accounting transactions, you make the purchase at the moment you receive the paper. You take the receipt, store it in your file system, and track the amount. The expense is for January, even though you don't pay for it until the month of February.

The same scenario applies to accrual accounting. accrual accounting would record the entire purchase price as an income at the time the sale is made, however, you will not receive all the money until four months have passed.

Which type of accounting approach is more suitable for businesses that sell online?

Accrual accounting gives you a clearer picture of your costs of selling goods each month. If you purchased paper in August, it is part of the expense for running your business- in August, not when you actually pay the bill. If you sell something in May, then you sold the item during May, not July when the customer finally pays the bill.

Also, it works well in conjunction with the management of inventory.

Imagine you spend $30,000 on purchase of inventory in September. You then will sell the inventory over the following four months prior to the holiday season. If you use cash accounting, you will mark your entire purchase of inventory as a cost during the month of September. In accrual accounting, you would mark it as an expense when you sell the product.

By using the cash-based approach it would result in a huge expense in September, and then artificially high profit margins in the months of October, November and December, since it appears like you don't have cost of selling goods.

Accrual accounting enables you to track the cost of doing business every month, and you can see which months produced the highest profits.

Three main financial statements

However, if you do decide outsourcing your accounting for e-commerce and bookkeeping tasks, you'll need to know how to understand and comprehend your financial reports. If you're doing it by yourself, using an ecommerce bookkeeping program to input transactions will allow you to produce three basic financial statements that are called income statements (also called the "profit and loss statement" or P&L), balance sheets, and cash flows.

Income statement

An income statement reports profit earned over a specified period of time, such as a month. The profit is referred to when people employ the term "bottom line." The profit you earn is your net income. In the event that you lose funds during the time then your net loss.

Balance sheet

Balance sheets report the amount of your liabilities, assets, and equity as of a certain point in time, typically at the end of each quarter, month or even a year. It's a snapshot of your financial health.

Assets are the things you own which have significance. The liabilities, which include accounts payable are the things you owe.

If you look back at the fundamental accounting equation that was discussed earlier, you'll see that equity simply is the difference between the liabilities and assets. Take away liabilities, and you'll have the "book value" or equity, of your company.

Statement of cash flow

The cash flow statement reports on how your cash on hand has changed during a certain time.

All three of these statements can be produced quickly through your accounting software provided you've diligently entered your financial details. If you don't have time to do that, it's another reason why you should hire the services of an e-commerce bookkeeper.

The most important financial metrics to use for eCommerce accounting

Taxjar put out a great piece regarding ecommerce accounting statistics. 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 the e-commerce company.

Below are the essential accounting metrics:

Revenue

Revenue is the term used to describe your gross earnings, prior to any expenditures have been subtracted. Revenue can be fairly simple to track. However, by itself, it gives you the wrong picture.

Contribution margin

It is the price you charge for a product less the price to market that product. This is similar to the COGS number from earlier but it applies to each item you offer. This figure does not take into account the operating costs.

Profit

Profit results when you have removed all costs from the revenue which includes operating and marketing expenses. If your revenue is high but the profits are a bit low, you either need to boost revenue or reduce expenses.

Conversion rate for eCommerce

The percentage is how many visitors to your ecommerce store who buy something.

Costs for customer acquisition

In general, it is significantly less to create extra sales to your current customers compared to acquiring an entirely new client.

Therefore, if your CPC is extremely high and you don't want to stop all of your efforts to market, there are two choices:

1. Make an effort to enhance or improve your marketing
2. Start marketing more to your current customers

Customer lifetime value

If you're just starting out as an ecommerce seller, you'll have a tough time determining this one for your first few years. But with good accounting software, you'll be able to estimate this amount in the future.

This amount helps justification for your marketing expenditures. In other words, if your CAC is high, yet your customer's lifetime value is greater, it's well worthwhile spending the time to gain the clients.

Average order value

For e-commerce startups that are relatively new, this is a superior metric over longevity value. If you invest 10 dollars to acquire a client, but they spend an average of $25 per order, that's a good deal, provided that the other costs aren't high. If you're able to ramp that upwards as you gain more customers, you'll do great.

Cart abandonment rate

The number of people who buy this is alarmingly high for online stores. In TaxJar's research, about 70% of online shoppers place items in their shopping carts however they don't purchase them.

The most effective method for cutting down on abandonment rates is to mail abandoned cart emails, which is easy to automate with the right email platform, like the MailPoet.

If you can lower that cart abandonment rate down to 60% or 50%, that will produce an impressive increase in sales. And if all it takes is a couple of automated emails it's an easy decision.

Return and refund rates for customers

Are there a large number of customers who have to return items for refunds? This is a sign that something is not right. Make sure you keep track of the situation and do everything you can to reduce it.

Five important ecommerce accounting tasks to take on

If you're at the beginning phases of being an e-commerce company owner, it's important to master your basic accounting tasks soon so you don't end being in hot water later. Just to be sure"hot water" can mean a lot of different things, including:

• Taxes not paidsuch as income tax, sales tax, or state and local taxes
• False tax returns
• The overspending of inventory
• Employers you cannot afford to hire
• Not reserving enough equity

These are actions you could take to get your accounting program off to a successful beginning:

1. Set up a business bank account

Small-scale business owners of Ecommerce often don't think about this as they're busy with many other startup business jobs.

However, business accounting can be challenging if you're combining private and corporate transactions. The business account is the one will be used for all of your business expenditures It's also the place where you'll pay your earnings from sales.

To open a business bank account, you'll require a corporate tax ID.

2. Be prepared for your employees and contractors.

If you're looking to hire employees, it is necessary to set up procedures for withholding tax. Even if you plan to manage the company on your own for now, you'll probably still employ contractors on specific projects. Contractors who are paid above the amount they earn per an year throughout the U.S. must be sent a 1099form. Be aware of:

• You can track who you've billed and how much you've paid to them.
• Get a W-9 form from each contractor
• Maintain current addresses for every person you employ

3. Find Accounting software

If you expect to have hundreds or even thousands of transactions per month, then you'll require accounting software such as QuickBooks Online, Xero, or FreshBooks. Businesses with fewer transactions can make do with an Excel spreadsheet, but businesses with high volume of transactions won't be able to keep up with manual entries.

Ecommerce accounting software can automate a lot of the accounting essential tasks and simplifies your life. It stores, records, and retrieves financial information and then uses this data to create accounts and financial reports.

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

The Reliability Principle of Accounting says that only transactions supported by documentation should be recorded. If there aren't any records of an activity that you don't have documentation for, it's not able to be counted as an expense or income. If you attempt to claim tax benefits on an expense that you've no proof you ever spent money on, that might be referred to as tax fraud.

Keep physical receipts. or take pictures of them and store them digitally. Keep all emailed invoices and receipts in a separate folder for emails and not only your regular inbox.

5. Pay attention to taxes and tax regulations

Tax regulations vary greatly based upon the type of company and where it operates. There are many things to consider, such as the compliance of sales tax and import tax when you have any foreign transactions. You should also know about tax withholding taxes for the quarter, as well as additional taxes that are specific for your country, state city, province, or area.

Those taxes will figure into your accounting software and financial reporting. Always consult with a tax professional to make sure you're using the proper procedures.There's plenty more to talk about tax administration. Two major tax concerns you'll need to tackle:

Paying sales tax and tracking the sale

Ecommerce sales taxes have been made extremely complicated. In fact, nearly every US state is now charging an online sales tax as well as the EU has its own sale tax structure.

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

Taxes on business that are estimated to be paid quarterly

Pre-tax business earnings are tax-free. Like a typical 1099-employee E-commerce businesses earn money before any taxes have been paid.

Like a 1099-employee You must pay your quarterly income tax. If you do not then the government can penalize you for being late on your tax bill.

How do you manage this? The idea is to avoid being a long way behind with your tax obligations. One of the best ways to handle your taxes for each quarter is to put the amount you will pay from your earnings each month, and then use that to pay estimated taxes during the quarter.

Your accounting software can easily manage all of this, along with taxes on sales. And speaking of software...

The reasons your business should use accounting software

Consider taking the time to think about this and ensure you understand that there are advantages to employing software for managing your ecommerce accounting tasks.

In the beginning, as you've seen, tax management has become extremely challenging, especially sales tax as well as revenue generated through multiple channels of sales. If your online store offers products throughout the US or in a large variety of states, you will be unable to manage everything by yourself. You have a business to run.

Your software will also manage the quarterly tax allotment that you'll have to pay for tax on income, and assist in the processing of year-end tax reports. In addition, if you're subject to state and local taxes, the complexity increases further. A good accounting program is able to meet all these requirements.

Second, accounting software helps you track your income and expenses 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.

The third benefit of accounting software is that it helps manage payroll, including contract workers. If you're not looking to spend money on ecommerce bookkeeping and accounting then you'll definitely require accounting software.

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

If you're not using accounting software, or you get it but you don't want to use it, you'll need a bookkeeper. However, as your company expands, you'll eventually also need to consider some of the many accounting firms that understand the nuances of ecommerce businesses.

Some business owners in the e-commerce industry like the idea that they can run their own show, including acting as the Chief Financial Officer. And as long as your business is small, you might be able to get away by doing it. But let's define "small."

If an online retailer is making up to $100,000 or more annually in net profit, that's already going get way out of control in terms of the accounting system you use if you're selling products in several states or nations. Sales taxes on their own get too complex.

There is also the issue of dealing with returns, shipping, chargebacks, and all other issues. Most ecommerce platforms sell lower-priced products, and deal in bulk. Unless yours is an one of a kind, which implies you'll be dealing with many transactions.

The greater the number of transactions, the more time it takes to keep track of the entire process. In fact, even an "small" ecommerce business making only $100,000 net profit annually selling goods which range from $5 to $20 is likely to have lots of transactions.

Now, if your business is only selling in a single area such as a state, province or country, your level of tax complexity goes way lower. In that scenario it is possible do it yourself -- if you want the extra effort.

Test your choice and see how it goes. You can always change your mind later.

Has accounting been covered

understands the responsibility business owners have each day. Manually inputting transactions and creating financial statements can be laborious and tax planning may give you a headache Accounting is an essential part of operating a business that is successful.