Ecommerce Accounting Guide for Business Owners

E-commerce has captured the business landscape by storm. While accounting is not interesting to many business owners, it remains a crucial component of e-commerce businesses. A lot of small business owners and e-commerce startup founders shoulder the accounting.

Though it may seem easy initially, with time, as you upscale your business, bookkeeping, and accounting may get overwhelming and distort your focus from core business activities.  We have prepared a comprehensive guide to help business owners understand the nuances of e-commerce accounting.

 

What is E-commerce Accounting?

E-commerce accounting is all about collecting, analyzing, and reporting the business revenue and financial data of an online business. The sales, revenue, returns, and other finance-related data of the online sales transactions are recorded, reconciled, analyzed, and reported following the tax laws and regulations. 

Data derived from balance sheets, income statements, etc., provide essential insights into the financial performance of a business. Since e-commerce accounting is an ongoing, continuous process, it can serve as the basis for financial estimations and projections. As it gives insights into the costs and revenue of a business, e-commerce accounting helps in data-driven decision-making. 

Types of Accounting for E-commerce Business

When it comes to accounting for e-commerce businesses, there are two common types. We have explained each of them in detail in the following section. 

1. Cash Basis Accounting

In cash basis accounting, the business records the revenue only when cash is received and not earned. A new transaction record is made only when cash flows into your business bank account or leaves your account in the form of expenses. In other words, it records income only when cash flows in and expenses only when money is paid. So, your account books carry all the information about the cash transaction involved in your business. 

Cash basis accounting follows a single-entry system.  Following is a simple example that shows how it works in real time. 

Income in 2-days to the business = $705

Pros of Cash Basis Accounting

Cash basis accounting is simple, straightforward, and does not demand financial expertise. So, it is ideal for small businesses, sole proprietorships, and e-commerce startups in the initial stages when there are fewer transactions and their primary intention is to record the cash flow. Given the size of the business, the amount of cash it has at its disposal is always known. 

An important advantage of cash basis accounting is that when you pay taxes, you will calculate income taxes only on the payments you have received. Your income tax might be lower as you are not accounting for payments you haven’t received yet. 

Cash basis accounting can be implemented using a single-entry system, so you do not need complex accounting systems. It is easy to reconcile the transactions at the end of a month or year.

Cons 

As cash basis accounting does not record or account for future receivables and payments, it is not a reliable method of accounting for medium and large-scale e-commerce businesses. 

Cash basis accounting does not provide a real-time picture of the revenue, profits, and losses, which can help drive major business and financial decisions. 

Cash basis accounting may not work if your business

• Deals with accounts payables and receivables, 
• Sell products or services on credit,
• Relies upon inventory or operates on a high stock model, 
• Has plans to apply for loans from banks,

2. Accrual Method

The accrual accounting for e-Commerce businesses recognizes and records transactions of sale and expense when it happens, irrespective of whether money is received. In other words, it records the revenue during its earned period, even when the cash is not received. Accrual accounting uses the double-entry method, and transactions are recorded as and when they happen, even if the money is not received or paid. 

The following is an example of the accrual method of accounting. 

Two-day income based on the above records = $7,800

The online sales revenue of $3,000 was made on day 1, and the money has already come into the business. On the other hand, the $7,000 worth of sales in stores on day 2 is credit-based, and the money is yet to arrive in the business.  Yet, the sale is recorded in the book of businesses based on the invoice.  

Similarly, the $700 shipping cost is paid immediately, but the $1500 that must be paid to a supplier is due the coming month, and the money is still in the account. This transaction is recorded when the raw material is ordered and received, not when the money is paid.  

Pros of the Accrual Accounting Method

Accrual accounting is more realistic and comprehensive as it records all business transactions. As businesses are not always about money and cash, accrual accounting presents a broader picture of the financial health of a business.  

Accrual accounting reduces errors and discrepancies as the transactions are recorded when they happen. 

With the accrual method, you can keep a tab on the payables and receivables of your e-commerce business. So, when you have a large-scale e-commerce business, the accrual method works best. 

As the accrual method records all transactions irrespective of whether or not the cash is paid or received, e-commerce business owners can determine the need for funding and plan loans. It serves as the basis for budgeting and forecasting. 

GAAP (Generally Accepted Accounting Principles) requires that companies use accrual accounting methods for bookkeeping tasks and preparing financial statements.

Cons

Accrual accounting for e-commerce businesses is more complex than cash basis accounting. As you need to record all transactions happening in the business, maintaining the whole accounting system is time-consuming. 

In accrual-basis accounting, you report income as and when a sale happens, unlike cash-basis accounting, where you report only when you receive the payments. So, in the former, you will have to pay taxes on the money you have yet to receive. 

Because you are accounting for future receivables and payments, your business may look more profitable than it is in reality. So, you must closely watch the bookkeeping and cash flow.

So, while accounting for e-commerce companies, you must use the accrual method to gain a comprehensive view of the business. Besides, the cash basis accounting method is allowed only for companies with an average annual growth receipt of $5 million or less. 

Types of Financial Statements in E-commerce Accounting

If you are an e-commerce business owner, there are 3 essential financial reports you must maintain and monitor regularly to get a tab of your business profitability and cash flow.

1. Income or Profit/Loss Statement

The income statement records all the revenue, sales, and income and subtracts expenses and losses from the income. So, it reveals how much a business is earning or the profitability over a specific period of time. The income statement is usually prepared at regular intervals, monthly, quarterly, or annually. It is also called a profit and loss statement. 

In the income statement, the income is categorized into operating income and non-operating income. The operating income is generated from ongoing, regular business activities, while the non-operating income accounts for income in the form of investment returns, property sales, etc. 

It is the primary statement you should prepare and maintain as it feeds as input for preparing the balance sheet and cash flow statement. 

2. Balance Sheet 

A balance sheet lists the assets, liabilities, and owner’s equity of an e-commerce business. It is usually prepared yearly, quarterly, or monthly and showcases a business’s performance at that point in time. After accounting for assets, investments, liabilities, payouts, and debts, a balance sheet reveals the business’s worth and financial health. It is an essential tool for e-commerce business owners to keep track of the assets and inventories and the loans and liabilities on the other. Using a balance sheet, business owners and partners can assess if the business is producing sufficient returns. 

3. Cash Flow Statement

In accounting, cash flow refers to the amount of money coming into your business and the amount going out of your business. As the name refers to, a cash flow statement records the amount of cash inflow and outflow during a specific period of time. Such statements help in accounting for e-commerce businesses as they help assess their liquidity. Further, by analyzing the cash flow information, businesses can make informed decisions about the e-commerce company’s future performance.

If you are using the accrual method of accounting, you may not have a clear picture of the money flow. But, by using the cash flow statement, you can track the cash flow and make impactful financial decisions and avoid unintended debt. 

What are the Top E-commerce Accounting Practices to Keep in Mind?

Professional accounting practices may seem hard in the initial stages, especially when you have just ventured into the E-commerce marketplace.  Here are some simple tips to get hands down with accounting practices and leverage the data and insights to make impactful business decisions.

1. Keep Track of your Payables

Maintain a record of your regular expenses and payables, along with an estimation of the weekly budget. This would help you plan your investments and high-budget expenses like setting up a new warehouse, adding more inventory, increasing your digital marketing spend, etc. 

2. Keep Track of your Inventory

Inventory has a direct, pronounced impact on your business as it affects your liquidity and cash movements. A lot of times, while sourcing the raw materials, the manufacturers are tempted to buy in bulk. In the process, they tend to overlook the inventory storage costs.  Always fix a threshold level for the minimum and maximum inventory that your business can handle. While making inventory decisions, always account for the financial health of your business. Buy and store only as much inventory as you need. 

3. Allot Sufficient Money and Time for Tax Payments

NSBA study shows that US taxpayers spend around 120 hours or more every year managing federal tax payments and filing returns. Maintaining the tax records well could help save considerable time that you can use to perform core business operations.  

John Hewitt, the founder of Liberty Tax Service, advises that businesses should set aside 30-40% of their earnings for tax payments. 

What are the Accounting Tasks Required for an E-commerce Business?

In this section, we have listed some of the most important accounting tasks that you must do on a weekly/ monthly basis to keep track of business transactions and make impactful financial decisions.

1. Track and Categorize your Business Transactions.

The first and foremost financial activity in an e-commerce business is to track your transactions. Make sure that you record all the transactions happening in the business. No matter how much you sell or buy, every sale and purchase transaction should be recorded accurately. 

While doing so, you must categorize the transactions as income or expense according to their nature. Merely recording transactions without organizing or categorizing them will add no value and may not be of great use in decision-making. As you become aware of every penny you spend, it helps establish control over the cash flow position of the business.

You can gain insights into the one-off, regular expenses, and monthly/ quarterly revenues by categorizing the transactions. Based on the cash flow insights, you can make strategic decisions about enhancing the efficiency and productivity of your business. 

2. Robust Inventory Management

Inventory tracking is a vital component of e-commerce business accounting. It is important that, as a business owner, you are aware of the inventory flowing in through your business and how much is in store at a given point in time. There are two ways of tracking and recording inventory flows. 

In periodic tracking, the inventory or stock is accounted for by manual means and recorded either in terms of quantity or value. This information is then uploaded to the system and maintained accordingly. 

In the perpetual method, the accounting software does the job of inventory tracking. The system updates the inventory information automatically when a sale or purchase happens. This helps maintain an optimal inventory all the time. Also, as it is automated and does not require manual interventions, the probability of an error is low. Using accounting software helps save time for ecommerce business owners who can invest their time into managing other core business operations. 

3. Maintaining your Business Budget

Budgeting is one of the crucial accounting tasks in e-commerce business accounting. You should account for all your expenses and the money you spend on website design, hosting, maintenance, inventory purchases, refunds, website maintenance, and so on. This way, you can minimize expenses and prepare a contingency fund to handle unanticipated expenses. You should also try setting up a budget calculator so you know how and where your money is being spent. 

4. Track Inventory Cash Flow

An understanding of the inventory cash flow helps understand the business position better and, accordingly, make decisions. It includes the cost that incurs to store the inventory. It also accounts for manufacturing costs. 

If you are an e-commerce store selling a product that you manufactured, then the inventory cash flow accounts for the cost of raw materials, equipment, maintenance, etc. By keeping a record of the inventory cash flow, you understand the effectiveness of the strategies and efforts you invest in maintaining the inventory in your business. For example, if there are losses, the inventory cash flow helps understand where they primarily happen. Say, if you are losing money due to damaged products, you can devise steps to ensure that such losses are mitigated.

5. Record-keeping Activities

Maintaining financial records is a key part of the accounting activity in an e-commerce business. You may have to keep some records for a few years as you may need them for follow-ups in case of discrepancies. Such records include invoices, account statements, tax return records, etc. Ensure that you store them safely in both hard and soft copy formats. 

6. Track Customer Returns and Chargebacks

On average, there is a return of 20-30% when it comes to e-commerce businesses. So, customer returns, and chargebacks are regular events in e-commerce businesses. They will impact the quality of your balance sheet if you don’t account for them properly. Customer returns are usually recorded as ‘Returns and allowances’ and are subtracted from the revenue. The initial transaction is recorded as an expense and added to payables, and when the product reaches back to your business, it is recorded as Returns and allowances. It is considered a debit because you return the amount to the customer. 

Chargebacks happen when a customer fails to receive the product or files a complaint seeking a refund and investigation when the business fails to deliver a product for which he/she has already paid. The credit card company through which the customer made his/her purchase requests the eCommerce business to return the amount paid. It also incurs the credit card processing fee. Similar to customer returns, chargebacks are recorded as Returns and allowances, while the processing fees and additional fees, if any, are recorded under expenses. 

7. Make your Tax Payments on Time

You must remember that you must pay sales and income taxes, irrespective of whether your business is running or not. You must be aware of the sales tax and income tax rates. The income taxes are usually annual, whereas the sales taxes are paid monthly, quarterly, or annually. If you are an e-commerce business owner with $1000 in taxes at the end of a year, then it is required that you file the returns quarterly. You must know how much tax you should collect from the customer and how much you should report. You must maintain a clear record of the taxes you have collected for every customer you serve. 

Tax rates could be confusing, particularly when you target and sell your products/services to an international customer base. The tax form requires that you must specify the source of the tax. As the local and state taxes vary based on your region, the cloud accounting software you use must be able to calculate tax rates automatically based on the customer’s shipping address. Also, ensure that you remit the taxes to the right state and locale in which your business is premised. 

8. Analyze the Financial Statements of your Business

As elaborated in the previous section, you must maintain important financial statements, including income statements, balance sheets, and cash flow statements. They help you understand the business performance, including your cash flow, debts, etc. 

Conclusion

Though e-commerce accounting practices may seem overwhelming, having the right accounting software helps simplify the tasks related to accounting and finance. Recording, maintaining, and analyzing your financials would help make important financial decisions that, in turn, translate into higher profits, revenue, and income. If you are an e-commerce business owner, it is time that you invest in accounting software with the right set of features and functionalities.