The path to starting a business is full of milestones. There’s the day your product is market-ready, the day you open your online store to the world, and the day you make your first sale—a major step that calls for celebration. Few things are more exciting, however, than watching the money start to roll into your bank account.
But before you break out the champagne and call it a day, it’s important to have a plan for tracking and managing your income and expenses. In other words, you need an ecommerce accounting system.
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What is ecommerce accounting?
Ecommerce accounting is the practice of recording, organizing, and managing all of the financial data and transactions relevant to the operation of an ecommerce company. Think of it as a subset of business accounting that is specifically set up to handle the unique needs of an ecommerce provider.
At its most fundamental, accounting is the practice of tracking and recording transactions and categorizing each one as either income or expense. Pretty simple, right?
Still, it can be easy to get lost in accounting terminology, particularly if you are new to the field. To simplify things, here are some of the key components of ecommerce accounting:
- Purchase order. A purchase order is a legally binding document from a client indicating the quantity and type of items they want to buy, with a commitment to pay a set price for those items. Although a purchase order is not payment, it should include payment details. Your company might use a purchase order to request raw materials for a vendor, or a client might submit one to you requesting a specific volume of goods or services.
- Sales order. A sales order is a document prepared by the seller (often in response to a purchase order) that outlines all of the details of a sale. A sales order should include client information, description and quantity of goods sold, sale amount, payment information, and delivery address and date.
- Accounts payable and accounts receivable. These terms refer to outstanding bills and invoices, or to the total amount of expenses not yet paid and revenue not yet received.
- Cost of goods sold (COGS). This is the total cost of production and distribution of a product. It is frequently calculated to include shipping, warehousing, credit card fees, and any other costs directly related to selling products. It does not include overhead expenses like payroll, marketing, software licenses, or office space.
- Ecommerce sales tax. This refers to the tax paid by an ecommerce business to the state in which a purchaser resides, provided that sales tax nexus exists between the seller and the state—meaning that the state has the right to tax a business, which it usually does if the business pursues any economic activity in the state.
What does ecommerce accounting entail?
Like all business accounting, ecommerce accounting includes both basic bookkeeping functions (like managing invoicing, payroll, and balance sheets) and more sophisticated planning and reporting functions (like preparing financial statements and creating a strategic tax plan).
Tax management, bookkeeping, and growth planning are often three major areas of emphasis.
Tax management can be complicated, and mistakes in filing or interpreting the tax code can have serious consequences for business owners. That’s why tax management (including both tax planning and preparation) is a core service of many accounting firms.
Ecommerce tax management includes tracking and remitting all applicable state and local taxes, calculating and filing quarterly estimated taxes, year-end filing, and distributing 1099s to contract workers.
Determining when an ecommerce seller must charge sales tax can be complicated—and is made more so by the fact that different states are governed by different rules. In general, if a seller has significant business in a state (also known as sales tax nexus), that seller is responsible for collecting and remitting state taxes for any purchase made from that state.
An ecommerce company always has a sales tax nexus in the state where the business is headquartered. Other common triggers include having a physical location or warehouse, an employee, or a shipping partner in a state, visiting a state for a trade show, or exceeding a certain dollar amount in sales in a particular state.
Accurate bookkeeping is a baseline requirement for all business planning and operations. This includes tracking and categorizing income and expenses, inventory management, and reviewing balance sheets.
It also includes tracking customer returns, a convenience that can both enhance customer loyalty and cause a bookkeeping headache. Improperly tracked, one return can throw off your sales, inventory, expenses, and sales tax records all at once.
An ecommerce accounting system should take into account customer returns and allow you to accept returns without throwing off your financial reports.
Planning for growth
There are few things as exciting as scaling a business. Thankfully, ecommerce accounting is more than just homework for business owners. It’s also the process of gathering all of the information you need to reach your business goals.
Ecommerce accounting can help you analyze:
- What products or services are most profitable for your company
- Your change in profit over time
- Your largest expenses and liabilities
- Opportunities to increase your profit margins
It can also provide you with financial benchmarking you can use to measure the success of new ventures (say, ROI on a new marketing campaign) and to think strategically about your next moves. Can you afford to buy out a competitor? How much are you spending annually on shipping, and would warehousing in another state save costs? When is your next busy season, and will you be ready?
Ecommerce accounting also includes running financial reports such as profit and loss statements and a statement of cash flows. Think of these as the owners manual for your business—your financial statements and reports represent everything you need to know about the workings of your company, all compiled in one place.
What do ecommerce business owners need to keep track of?
Business accounting requires keeping track of all of a company’s transactions, inventory, and financial data. This includes metrics like cash flow and gross profits, balance sheets, and profit and loss (P&L) statements.
- Cash flow. Cash flow is the movement of money into (and out of) your business. Cash flow management can help you meet all of your obligations and avoid incurring unintended debt.
- Gross profit. One of the key metrics for running your business, gross profit refers to total revenue minus the cost of goods sold. Expressed as a formula, it reads gross profit = revenue - cost of goods sold.
- Gross margins. Gross margins are calculated using the same data as gross profit, but this metric is expressed as a percentage of total revenue. The formula for calculating gross margins reads gross margins = (revenue - cost of goods sold) / revenue. For example, if your company makes $10,000 selling goods that cost you $4,000, your gross profit is $6,000 and your gross margins are 60%.
- Balance sheets. Your balance sheet will include three major categories: assets (including cash, accounts receivable, and inventory), liabilities (including accounts payable, wages, and income tax), and the combined equity of all shareholders.
- Profit and loss. Profit and loss statements provide a comprehensive view of the profitability of your business over a certain period of time. They calculate total revenue minus all costs associated with running your business, including COGS, marketing expenses, payroll, and overhead. If this number is positive, you’ve made a profit over the period of time specified. If it’s negative, you’ve taken a loss.
Accounting methods for ecommerce sellers
There are many different accounting providers available—from accounting software platforms to traditional accounting firms. Before getting started with a vendor, however, you’ll need to choose an accounting method.
The two accounting methods are cash accounting and accrual accounting. An ecommerce company can use either method, but not both at once. Switching methods requires filing paperwork with the IRS.
Cash basis accounting
Cash accounting is a method of accounting that measures the transfer of cash. Seems simple, right? Under this method, you might receive a purchase order for an $800 handmade coffee table, make the table, and then ship the table to your client. Under a cash accounting method, you only record income from the table when the purchaser’s payment lands in your account.
The same goes for expenses. You might owe a videographer $10,000 for a series of product videos to be completed at the beginning of Q2, but because that $10,000 is still in your bank account at the end of Q1, you’ll end up paying taxes on it during the first quarter. For accounting purposes, this debt only matters once the money leaves your account.
Accrual accounting, unlike cash accounting, measures a transaction when funds are earned or when expenses are incurred, not when payment changes hands.
This method is more frequently used by large companies, and it requires more specialized accounting knowledge and a more hands-on approach to account management than the cash-basis method does. Although accrual accounting can provide a more accurate picture of your business’s long-term financial picture, it has the potential to mislead business owners about the current state of their accounts: The aforementioned coffee-table maker would “earn” $800 as soon as she finished her table, for example—but her bank account might still be empty.
Getting expert help
Whether they use online accounting and bookkeeping software, hire an online bookkeeper, or hire a traditional accountant, almost all small business owners seek expert accounting help.
If you have an existing relationship with a business accountant, you might find it beneficial to tap that person’s expertise in helping grow your ecommerce business. Some traditional accounting firms have also evolved to support ecommerce companies, either by managing ecommerce bookkeeping internally or by consulting on the use of popular accounting software platforms like QuickBooks Online.
Many ecommerce business owners rely fully on accounting software. These services can integrate directly with your ecommerce platform and bank account, effectively automating a huge amount of bookkeeping labor and reducing the potential for human error. An online bookkeeper can also assist in operating tax and accounting software, performing functions like categorizing transactions, creating and sending invoices, and reconciling accounts to check for accuracy.
Today, many accounting software platforms are also built with ecommerce companies in mind. They are designed to streamline processes like accepting returns and collecting state and local taxes, and some also offer consulting add-ons, in which a trusted accountant with business planning experience can also help break down the information in your financial reports, providing strategic tax planning and business development advice.
Reliable, accurate business accounting and bookkeeping practices are critical for any business owner. For one thing, accounting activities allow you to manage and predict cash flows so you can plan for the future and maximize your potential profits and growth. Ecommerce accounting can also help you manage your tax obligations—ecommerce companies are subject to a specific (and often complex) set of tax guidelines, and nobody wants to be surprised by a tax bill or end up owing penalties to the IRS.
As your business grows, your balance sheet will inevitably become more complicated. Without a plan in place, what might at first seem like a simple DIY job can become a nightmare of miscategorized transactions, missing funds, and accounts that won’t reconcile.
Getting set up with an accounting system as soon as possible—preferably one tailor-made for an ecommerce company—can minimize headaches (and maximize profit) for years to come.