Ecommerce accounting basics: The Principles to a Profitable Store

The running of an online business requires more than great concepts, products, marketing, and inventory. You also need an ecommerce accounting system that can track the financials. What is your spending? What is your profit? Do you have enough money in your budget? Is the government happy with the business you run? Ecommerce accounting employs well-known procedures for keeping track of the financial information of your business and transactions. It also keeps you current on tax laws as well as payroll and profit.

No matter if you're only beginning your online store, or you've been in the business for some time and realize that you require help in tracking your company's financials, this accounting guide will get you going in the right direction.

The accounting software for eCommerce lets you evaluate the financial condition of your company and create more accurate financial projections when the business expands.

What are the implications of ecommerce accounting?

The foundation of ecommerce is transaction and inventory. The company makes sales. You ship products. You buy and replenish inventory.
The fundamentals of accounting for e-commerce start with a method of tracking and reporting transactions. These include purchase order, invoices, costs, and taxes.

It goes further beyond that. Accounting firms analyze the information and then use it to prepare financial statements that allow them to evaluate and present the financial condition of your business.Ecommerce companies also require some particular attention to meet the basic principles of the business model.

Think about what happens when you make a sale in your ecommerce store. That means the customer uses their credit card, and then makes payment to your payment processor. How do you know this sale can impact your cash flow?

• Your payment processor has received money, but it's not yet in your bank account as of yet.
• Sales tax is a cost in a variety of ways, and may be incurred from a different nation or state
• Inventory declines
• Credit card and/or payment processor charges are incurred
• The actual income from sales differs from the sales price

Whichever sales channel you choose, making even a one sale can impact numerous aspects of your financial statements. The repercussions from that one sale will be visible in your records of financial transactions over the next couple months. If the purchase does get returned, many of these transactions will need to be reverted or altered.

This is just one of many sales.

The tracking of some of this is the job of the bookkeeper. we'll talk about the differences between ecommerce bookkeeping and accounting some time later.

In the beginning, we'll go over the most basic accounting terminology.

Basic accounting terms

These are the top terms to know for ecommerce accounting:

Transactions

In accounting terminology, a transaction is when cash is paid, received or requested by a vendor or business.

A transaction could be any of the following:

• A business's owner can invest money into the company
• Sales revenue
• Invoices
• Expenses like salaries or travel costs, marketing and building cost
• Purchased assets, like automobiles, office equipment, property, or materials

One transaction may contain multiple parts. If you are paying an hourly employee, for example it is important to determine the length of time they worked, their net wages, tax deductions and their net pay. Accounting software that is of the highest quality can perform all of these functions.

Transactions for ecommerce companies may be complicated due to particular factors, such as sales taxes and timing delays caused by the separation between the consumer and the business.

Do you, for instance, assess sales tax right on the day of purchase? If so then what happens to that amount if the item is returned after a month?

Accounting for Ecommerce aims to control your processes and transactions to ensure the aforementioned issues do not cloud the financial picture of your business.

Debits and credits

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

Debit: A record of money that was debited from your bank account. The debits will show on your bank statement whenever you purchase.

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

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

Liabilities are obligations that a company has to meet but need to be met. A liability is a claim against the asset shown in a balance report.

Equity is the sum of funds after deducts have been taken out of them.

Let's consider how these terms are incorporated into the main accounting equation:

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

A debit is added to the left side of the equation, as an asset. Credits are added to the right.As one simple illustration when you sell a purchase of $500, that $500 gets debited, and then added to your assets in the business. It is also credit as Owner's Equity in the form of revenue. If something gets deducted and credited, another item must also be added, as it helps to keep the balance.

It's an extremely simplified explanation, but it gives you a basic idea of what the accounting software does when you record transactions.

Cost of products sold (COGS)

The accounting for Ecommerce should pay close attention to the cost of goods sold. It is all expenses required for selling the product, but not including the costs of payroll and marketing.

COGS covers all inventory costs, including purchasing, storing, managing, and shipping. The cost of inventory is one of the largest expenses for an online seller If you don't have an accurate accounting picture of the cost of goods sold, your profit margin and tax-deductible earnings will be inaccurate.

An inaccurate COGS also makes it harder to know the amount to budget for marketing, what prices to be set, the amount of inventory you should order, if it is necessary to hire employees and the amount of warehouse space you need to purchase.

Profit margins

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

    Margin = (Revenue - Cost of Goods) / Revenue  

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

Receivables and accounts payables

The term "money" refers to cash which hasn't yet changed hands, however it is planned to.

The term "accounts receivable" refers to any amount that's due on your account in the bank. As an example, if for example you mail an invoice, it will be placed in accounts receivable until the client actually makes payment to you.

It works the exact as it does in reverse. If you make an order with a vendor, and that vendor sends you a purchase order that is deposited in your accounts payable until you actually make the payment.

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

There's some overlap between ecommerce bookkeeping and accounting. But in general, the different is that bookkeepers handle events, and accountants compile the data and then analyze it in order to provide a precise and useful overview of your business budget.

If a sports analogy helps you understand the role of bookkeepers, they are the announcer of play-by-play accountants are similar to the analyst or color commentary. The bookkeeper records what has happened. Accounting professionals explain the meaning behind it.

What does an ecommerce bookkeeper do?

Tasks in bookkeeping are primarily focused on transactions, records as well as financial institutions. If you employ employees, the bookkeeper manages payroll. They can also handle things like:

• Invoice processing
• Receipts must be sent
• Record what comes in and out of the business bank account
• Purchases of inventory records
• Check your bank account reconciliation every month
• Create monthly financial reports
• Prepare year-end financial statements as well as tax documents

A thorough bookkeeping system for e-commerce can help you build a financially solid and stable business model.

What is an accountant who specializes in ecommerce? do?

A ecommerce accountant can do things like

• Track and analyze operational expenses and business performance
• Conduct financial forecasting
• Examine your financial statements- including those from your bookkeeper
• Plan your tax strategy, which includes filing taxes
• Review your cash flow management

The goal of the accountant is to help ecommerce business owners make sound financial choices.

Do you have the money to pay new employees? Do you need to expand into a different country or state? What is the minimum amount you can be charging for your new product?

Ecommerce accounting in its most efficient form will be able to answer these types of questions.

The accounting methods used by e-commerce sellers

There are two basic techniques of online accountingthe cash method as well as that of accrual. The accrual method is the more popular one and, depending on the scale and type of your company, it could be legally required.

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

Accounting on cash basis

In the cash basis accounting system, a transaction is recognized when cash has actually been transferred. When you pay an invoice, cash basis accounting marks that as an expense. When you receive the invoice during January, but you settle it in March, then cash accounting records the invoice as an expense during March.

Income works the same way. When you have a sale that is followed by a client signing for a monthly payment plan that will spread out the payments across four months. In cash accounting, you 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 is completed and an invoice sent. Suppose you place an order for a fresh paper for office in January, and then put it on your corporate credit card. Office paper arrives in a matter of minutes, but aren't able to pay for it until February, after which the credit card accounts are received.

When accounting for accrual, the transaction happens when you get the document. You take the receipt and save it to your system for file storage, and record the expense. This is an expense that was incurred in January although you're not able to pay for it until February.

In the same way, accrual accounting would record the total purchase cost as an income at the time the purchase is made although you may not get the entire amount until after four months.

Which accounting method is better for ecommerce businesses?

Accrual accounting provides you with a clearer picture of your costs of selling goods each month. If you purchased paper in August, that paper was part of the cost of running your business -but in August, not until you get around to paying the invoice. If you make a sale in May, you made the sale in May and not July when the customer finally sends the money.

Additionally, it is more effective with managing inventory.

Imagine you spend $30,000 on purchase of inventory in September. Then, you decide to will sell the inventory over the following four months prior to the holiday season. If you use cash accounting, you could mark your whole purchase of inventory as a cost during the month of September. If you use accrual accounting, you'd mark it as an expense as you sell the product.

With the cash approach, you'd have a big expense in September followed by artificially high margins of profit in October, November, and December. This is due to the fact that it would appear like you don't have expenses for the sale of your products.

Accrual accounting enables you to compare the expenses of running a business each month, so you can see what months have the best profit margins.

Three financial statements that are the primary ones

Even if you plan to outsource your ecommerce accounting and bookkeeping, you need to know how to understand and comprehend the financial statements. If you're working on the work by yourself, using an ecommerce bookkeeping software to record transaction data will enable you to produce three basic financial statements that are called income statements (also known as "profit or loss" statement" or P&L), balance sheets, and cash flow statements.

Statement of income

The income statement is a report of the profit you earned during the specified time period like a month. The profit people refer to when they refer to the phrase "bottom line." Your profit is the net amount you earn. Or, if you lost money during that time period the net loss.

Balance sheet

Balance sheets provide information on the amount of your liabilities, assets, and equity as of a certain date, usually after the end of the quarter, month, or year. This is a quick snapshot of your financial condition.

Assets are items owned by a person that have worth. The liabilities, which include accounts payable are the things you owe.

If you go back to the accounting fundamentals that were discussed previously, you'll discover that equity is essentially the sum of the liabilities and assets. Add liabilities to assets and you'll have the "book value," or equity, for the business you run.

Cash flow statement

The statement of cash flows provides the way your cash balance is changing during a certain time.

All three of these statements can be produced quickly using your accounting software as long as you've diligently entered your financial data. If you're not able to make time to complete this task, that's another reason why you should hire the services of an e-commerce bookkeeper.

Important financial metrics that are essential for eCommerce accounting

Taxjar put out an excellent piece about ecommerce accounting metrics. Remember, accounting isn't just about keeping financial records. Accounting can also inform you regarding the financial health as well as the growth or decline of your online business.

These are the most important accounting measures:

Revenue

Revenue refers to your total income, even before expenses are taken out. It is relatively simple to monitor. However, by itself, it gives you only a partial picture.

Contribution margin

The selling price is minus the cost to sell that product. It's similar to the COGS figure from before however, it is for every single product you sell. It doesn't include operating expenses.

Profit

Profit comes from the results that occur after you subtract all of your expenses from your revenue, including marketing and operating costs. If you have a high revenue however your profit margins aren't as high, you either need to improve your revenue or cut expenses.

Ecommerce conversion rate

It is a percentage of customers who visit your online site who make a purchase.

Costs for customer acquisition

Typically, it costs a lot less to make additional sales to your existing customers than to acquire the services of a brand new customer.

If your CAC is very high and you're not willing to stop all of your advertising, you've got two choices:

1. Try to improve or optimize your marketing
2. Get started marketing to more of the existing customers

Customer lifetime value

If you're just starting out as an eCommerce seller, you'll be having difficulty making this decision for the first few years. But with good accounting software it will be possible to estimate this amount in the future.

This amount helps justify your marketing expenses. In other words, if you have a high CAC, yet your customer's lifetime value is significantly greater, it's well worth the cost to acquire the customers.

Average order value

Especially for newer ecommerce businesses It's a much superior metric over longevity value. If you pay $10 to get a customer however they'll spend on average $25 per order, that's a good deal, provided that your other expenses aren't expensive. If you are able to scale this upwards as you gain more clients, then you'll have a great time.

Cart abandonment rate

This is a shockingly high number in the case of e-commerce sites. According to TaxJar's sources approximately 70% of online shoppers place items in their shopping carts but do not purchase them.

The most effective method for reducing abandonment rates is to mail abandon cart emails. This is simple to automate using the correct email service, like MailPoet.

If you are able to bring that abandonment rates of carts to 60% or 50 percentage, it will result in an impressive increase in sales. And if all it takes is just a few automated messages it's an easy decision.

Return and refund rates for customers

Do a lot of customers are returning products to get a refund? This is a sign that something's not right. Keep track of this and do everything you can to keep it low.

Five essential ecommerce accounting issues to be tackled

If you're in the early stage of becoming an online company owner, it's important to be able to handle the accounting basics as soon as possible to ensure that you do not end up in hot water later. And just so we're clear hot water can mean a lot of different things, including:

• Taxes not paid- income tax, sales tax, or state and local taxes
• Tax filings that are not correct
• The overspending of inventories
• Employers you cannot afford to hire
• Withdrawing too much equity

Below are a few ways to get your accounting program off to a successful starting point:

1. Establish a separate bank for business account

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

However, business accounting can be complicated when you mix personal with business transactions. Business accounts are the ones you use to pay for the business costs, and it's where you'll deposit income from sales.

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

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 taxes. Although you may plan to manage the company by yourself for the moment, you'll probably still employ contractors on specific projects. Contractors that are paid over a certain amount per calendar year within the U.S. must be sent a 1099, so be sure to:

• You can track who you've billed and the amount you've paid them.
• Get a W-9 form from every contractor
• Keep current addresses on file for all employees you have

3. Find Accounting software

If you expect to have hundreds or even thousands of transactions per month, you're going to need accounting software like 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 pace with manual entries.

Ecommerce accounting software automates most of the essential accounting tasks and makes your life easier. It records, stores, and retrieves data from financial records and uses it to produce financial reports and statements.

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

The Reliability Principle of Accounting states that only transactions with supporting documents should be documented. If you don't have records of a transaction, you can't count it as an income or expense. If you attempt to claim a tax deduction for an expense you have no evidence of having paid for, that could be considered tax fraud.

Maintain receipts in physical form. Take photos and keep them in a digital format. Save all invoices and receipts in separate folder for emails and not only your regular mailbox.

5. Be aware of the tax laws

Tax laws vary drastically based on the kind of business and where it operates. You need to know about sales tax compliance, import tax if you have any overseas transactions. Tax withholding, quarterly taxes, and any other taxes specific to your state, nation, province, city, or even region.

These taxes are incorporated in the accounting software you use and your financial reports. It's always best to seek out a tax expert to make sure you're using the proper procedures.There's plenty more to say about ecommerce tax administration. There are two major taxes you'll have be aware of:

Taxes on sales and trackers

Sales taxes for online sales have become very complicated. The majority of US states now has an online sales tax as well as the EU also has a sales tax system.

Within the U.S., each state has different tax rates and also has its own set of rules for how sales tax should be applied.

The payment of estimated quarterly business tax

Business income is pre-tax. Just like a 1099 employee E-commerce businesses earn profits before taxes have been paid for that revenue.

And like a 1099 employee, you need to be able to pay the quarterly tax. If you fail to do so, the government will punish you for not paying in paying your tax bill.

How do you manage this? It is important to stay clear of being a long way behind with your taxes. One of the best ways to handle tax obligations for the quarter is to set an amount of your earnings each month, and use it to pay taxes estimated each quarter.

Your accounting software can easily deal with all of these, along with the sales tax requirements. And speaking of software...

Why your ecommerce business needs accounting software

Take the time to think about this and ensure you understand the benefits of using software to help manage your ecommerce accounting tasks.

As you've observed, tax administration has become exceptionally challenging, especially sales tax and revenue from multiple sales channels. If your online store sells products across the US or across a huge amount of states, you'll not enjoy trying to keep up with the demands of this by yourself. You have a business to run.

Your software will also manage the tax amount the tax payer must pay in taxes on your income and assist in the preparation of your year-end tax reports. And if you are also subject to state and local taxes, this complexity will increase to a higher degree. A good accounting program is able to meet all these requirements.

Accounting software also helps you keep track of your expenses and income through the creation of financial statements so you know your margin for profit each month, and can see your business equity.

Thirdly, accounting software can help to manage the payroll of contract workers. If you do not want to pay for ecommerce bookkeeping and accounting it is a must to have accounting software.

Do you need to hire bookkeepers, accountants, or do it yourself?

If you're not using the accounting program, or you do get it but you don't want to be responsible for using it, you'll need to hire a bookkeeper. But as your business grows it will eventually be required to consider some of the many accounting firms that understand the nuances of businesses that rely on e-commerce.

Some business owners in the e-commerce industry love the thought of running their own show which includes acting as Chief Financial Officer. in the event that their company remains small, you might have the ability to do it in this way. But let's define "small."

When an e-commerce business is earning up to $100,000 or more each year in net income this is already likely to start getting way out of control in terms of your accounting system if you're selling products in multiple states or countries. The sales taxes alone just get too complex.

There is also the issue of dealing in return shipping charges, shipping, and all the rest. The majority of e-commerce platforms offer lower priced products, and deal in bulk. If yours is not an exception to that, that is a sign that you'll have many transactions.

The greater the number of transactions, the longer it will take to record and track everything. In fact, even the most "small" eCommerce business earning only $100,000 net profit annually selling goods 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 even a country, the level of tax complexity will go down. In this case there is a chance to do this yourself, if you want the extra work.

Test your choice to see how it performs. It is possible to change your mind later.

has accounting covered

is aware of the responsibilities business owners have each day. Manually inputting transactions and creating accounting reports can be very time consuming and tax planning may give you a headache, but accounting is essential to managing a profitable business.