Cash basis accounting and accrual basis accounting are the two main methods by which to document your eCommerce accounts. 40% of businesses believe that business accounting can take up to over 40 hours in a year. So do you know how to choose the right one to maximize efficiency? Learn learn Accounting basics for eCommerce Businesses.
Once you know the fundamental differences, there are strategies you can put in place to help. Read on as we give our essential guide on eCommerce accountancy and if you should choose, cash basis accountancy or accrual.
- 1 What Makes eCommerce Accounting Different?
- 2 What Are the Challenges of e-Commerce Accounting?
- 3 What Do You Need for eCommerce Accounting?
- 4 Cash Basis Accounting vs Accrual Basis Accounting
- 5 How to Track eCommerce Inventory
- 6 Understanding the Cost of Goods Sold
- 7 Calculating Shipping
- 8 Organizing Your Accountancy
What Makes eCommerce Accounting Different?
Many of the accounting basics for any business are the same for eCommerce. However, some major differences can make it more troublesome. Add this to the fact that transactions occur worldwide on a 24-hour basis and it becomes quite different from accountancy you may have done before.
Inventory and COGS
These are two of the most important figures you need to know. The cost of goods sold (COGS) is the price of each item. Understanding and tracking them is imperative, as, unlike other businesses, many external factors can impact profit margins.
Analyzing data based on transactions will also differ. This is because transaction data does not come through bank statements but through selling channels. This can mean additional charges such as transaction fees, shipping, and commissions which may need handling differently.
What Are the Challenges of e-Commerce Accounting?
The above factors present several unique problems when it comes to eCommerce accounting. Below are the main challenges that need addressing.
Managing inventory does not just become a case of what is sitting in a warehouse. You have to deal with outgoing stock, items in shopping carts, returns, and stock in production or transit to you. When you add in SKU numbers, along with different countries and marketplaces, accounting becomes tough.
Online sales tax differs by country and is constantly changing. This means you need to keep track of local regulations and be up to date to avoid incorrect accounting.
What Do You Need for eCommerce Accounting?
To begin accounting for an eCommerce business, there are several items you will need. Others are not essential but will make the job much easier.
If you have a corporation or partnership and are in the US, you will need an Employer Identification Number from the IRS. Other countries and provinces will have a similar identifier for your tax documents.
Open a bank account that is strictly for business purposes. Don’t use this for any personal expenses or expenditures. You should also set up business versions of payment processing like PayPal.
Finally, invest in accounting software. This will save you a lot of time and make tracking cash flow and inventory easier. You may also wish to sign up for online accountancy services to deal with your tax.
Cash Basis Accounting vs Accrual Basis Accounting
These are two main methods of accounting and they have fundamental differences. These arise depending on when revenue and expenses get calculated. The cash method calculates revenue that is paid or deducted when it occurs, while accrual looks at revenues and expenses that are due.
What is Cash Basis Accounting?
Cash basis accounting is easier and faster. Your statement of income will only include money received. It will only record expenses when they have gone out.
What is Accrual Basis Accounting?
Accrual-based accounting includes a prediction of future revenue. Income statements may include details of the delivery of products to a customer, even if they have not paid the balance yet. The cash sheet will also include the cost of expenses even if they have not been paid out or are not yet due.
Which Is the Best Method When Accounting For Ecommerce?
The cash basis method is used for smaller organizations and businesses. It is an easier method of keeping track of personal finances. However, it does have disadvantages and for larger businesses, accrual may be better.
A cash basis does not give the actual financial health of a company. It may seem like they have a healthy current income, but they could have lots of accounts payable and be in debt.
As the accrual method shows future incomes and outgoings, it is a better long-term overview. This could be better for investors.
A simple example of this may be a company that sells seasonal goods. In spring, the cash method may predict they have a very low income. Yet orders may have been placed for the end of the year, with huge numbers ready to be paid up.
Accrual does have disadvantages as well. It does not map current cash flow, which can be just as important to a company. Accounting using this is also harder to do as you have to record unearned income and already paid expenses.
Ecommerce Accounting Tips for Tracking Cash Flow
Whichever method you choose, there are a few tips that may help you track your cash flow. You should always be watching the timing of money coming in and out.
- Don’t pay balances earlier than you have to
- Keep all of your statements simple and easy to read
- Always have a reserve in your business bank account
To increase monthly sales, you may be able to offer subscription plans or monthly payment fees. This can help create some stability as you will have money coming in.
How to Track eCommerce Inventory
Once you have decided on the method in which to track cash flow, you can find a method to track inventory. This will make accounting for an eCommerce business much easier as you have a better understanding of your assets. If you are selling a service, this step will not apply.
Too little stock and you can run out of product to sell. Too much and you waste money on items that are not selling. They will also take up space that could be used for other items.
In addition, items in your inventory can change, impacting your projected net profit. For example, if you have an item worth $50 and the price of them jumps on the global market to $100, then you stand to make more money. However, it can also drop, causing a loss.
Start by setting a minimum inventory for items you should always have in stock. Once you pass this number, you can reorder. This ensures you never run out and miss out on sales.
Always make sure you include any costs for packaging and wrapping products within your inventory costs.
Shrinkage is the term used when the inventory on paper is not the actual stock in your storage location. This can happen for several reasons. Items may get broken, lost, or even stolen.
When items are in a physical retail store, shrinkage tends to be higher as people can steal goods. In warehouses, shrinkage is very little, though you should still hold regular stock checks. Luckily, if you store goods in your house it should be almost non-existent.
Understanding the Cost of Goods Sold
In a standard retail supply chain, you buy a product and sell it at a higher price. This makes calculating a profit margin simple. With eCommerce, several variables can make this complicated.
To begin with, you have the parts of a product and their cost. Packaging must then get added to it. You also need to add the labor costs of putting the product together.
Once you start paying different prices for various products and paying different wages to collate them, it gets complex. This is why it pays to keep it simple.
Total up the cost of making and creating a product including labor, then deduct it from your sale price. This is your gross margin and should not get confused with profit. This may have other expenses included.
There is a train of thought that states shipping costs should not be included in the cost of goods sold. Yet when it comes to eCommerce, shipping is such a vital part of the process that it can have a huge impact on costs.
Most consumers will look at the price and the cost of shipping. If you are not shipping as fast as competitors at a competitive price, you may lose sales. You may have to reduce margins, effectively subsidizing your shipping costs, to be able to compete.
Another factor that can change margins is when you offer free shipping over a certain value amount. Once someone buys more than this, margins change as you are deducting the value of shipping from it.
Shipping prices will also go up and down depending on the amount you sell. As it is almost impossible to get these costs accurate, it is best to go off an estimate. Get the percentage amount you pay for shipping every month and calculate this average into future accounting.
Organizing Your Accountancy
Getting the accounting basics right is easy with our guide. Decide if you are choosing cash basis accountancy or accrual, then get cash flow and inventory correct. After this, put in place methods to record tax and keep track of the cost of goods sold.
Now that you learned more about Accounting basics for eCommerce Businesses, Tax Savers Online can make the job much easier. We provide tax and business strategies from experts. You can visit our collection of the best resources here to help you do your business accounting.