Accounting is one of those painful necessities that you need to do in order to keep your business going. It’s boring and for the most part, business owners would rather talk about something more exciting like expanding their product line, but there’s no avoiding it. In fact, eCommerce is the fastest-growing retail market projected to hit $4.058 trillion in sales in 2020. If you want to run a profitable eCommerce business, you must understand the accounting basics. I promise they aren’t too complex. As long as you grasp the basics, you’ll be knowledgeable enough to understand and question what the numbers tell you. Below are ten key accounting tips for business owners to understand everything you need to know to run a successful eCommerce business.
1. Keeping track of your cash flows
The primary purpose of any business is to make money and in order to know exactly how much money you are making, you need to watch your cash; everything that comes in and out of the business. Be it eCommerce or any other business, most businesses will focus primarily on generating more sales to improve cash flow. While this method can be effective, there are also other, more practical, ways to achieve this. The first step is trying and reducing any unnecessary expenses. Even cutting down on minor costs can have a significant impact on your expenditures. You also need to put some strategies in place for on-time payments. For example, be careful with the credit terms you offer to your customers. Unless they buy your products on a regular basis and have a good credit history, it is best to take payment upfront.
You also need to take note of the timing of your cash flows. For example, when are your bills and receivables due? When do you have to pay your employees?
In order to effectively manage your cash, you can try doing the following:
Track your expenses and earnings on a weekly basis. If there is a discrepancy between the two, you’ll know there is trouble.
Don’t make a payment on your bills until the due date. If there is a 30-day credit period, then you do not need to rush yourself. This is important because you may face a shortage of cash when you need it.
Offer monthly subscriptions or payment plans to customers so that money comes in on a timely basis.
Keep some amount reserved in your bank account in case of cash emergencies.
Lastly, you can improve your cash flow by negotiating better terms with your suppliers. Incentives like longer payment terms, bonus goods or services and discounts on repurchases can free up the cash flow for your business. You can also negotiate upon returning goods that go unsold within a certain period.
A key method that can help avoid cash flow issues is carrying out a cash flow forecast on a regular basis. Doing a cash flow forecast can be difficult, and you may end up with overly exaggerated assumptions on sales or underestimated expenses. If you need advice on how to build a cash flow forecast, you can reach out to our team of experts for advice.
2. Managing Inventory
Inventory includes both the goods that are available for sale, as well as, the raw materials you use to produce these goods. An unnecessary inventory buildup impacts your liquidity and will reflect badly on your assets. It’s imperative, therefore, that you keep your inventory in check and decide a minimum volume that you want to keep. The rule of thumb to follow here is – Keep only as much as you need.
You don’t want to run out of inventory because then you run the risk of losing sales. You also don’t want to have an excessive amount that goes unsold because again, you’re losing money.
There’s also the question of price fluctuations. If the market price shoots up, your inventory will have more value than it did the day before. The opposite can also happen. A good business needs to have a high inventory turnover rate in order to thrive. This helps minimize the impact of external forces on your sales as well.
Lastly, we have inventory shrinkage. Shrinkage is basically when you lose a portion of your inventory due to theft or damage. It’s important that you physically count your inventory in order to keep track of losses from shrinkage. Since eCommerce businesses usually operate out of warehouses or homes, the chances of shrinkage are considerably low.
3. Cost of Goods Sold
Your cost of goods sold is the cost incurred from the production of goods that are to be sold. This includes direct labor costs and the cost of materials used in production. Expenses incurred in the distribution and sale of the goods is not included in this. Calculating your cost of goods sold can be difficult, especially if you bought the raw material at different prices and are also paying different salaries to the people involved in production. The best way to resolve this is to use the Weighted Average Method. You can also use the Specific Identification Method.
Tracking the correct COGS numbers is important for your business as these figures play a critical role in accurate financial reporting. Incorrect COGS numbers will automatically reflect a higher or lower gross profit on your income statement and lead to false conclusions about the net income of your business.
4. Counting Other Expenses
Besides the cost of goods sold, there are other variable and fixed costs as well that factor in. Fixed costs are the costs incurred by your business regardless of whether you’re producing or selling anything. Some of the fixed costs related to an eCommerce business include:
Technology and software costs
Domain name and hosting (yearly payment)
Rent and utilities
Variable costs are the costs incurred according to how much product you sell. These can include:
Marketing and advertisement
While it’s hard to go around your fixed costs, understanding the nature of your variable costs can help you minimize them and increase the efficiency of your operations.
5. Calculating the Break-Even Point
The breakeven point is when your revenue equals your expenses. When you hit break-even, your profit stands at zero, but you’ve managed to cover your costs with the sales generated. Calculating break-even involves factoring in your fixed and variable costs, the product price and the contribution margin. The contribution margin is the value obtained after subtracting your variable costs from the selling price. In order to calculate the breakeven point, the following formula can be used:
Break-even Point = Fixed Costs/Contribution Margin
Contribution margin = Average Price – Variable Costs
If your break-even point is too high, then you can either raise your prices or lower your variable costs. This can be done by increasing your shipping charges, using cheaper materials, etc.
6. Tracking Your Earnings Before Tax and Sales
Now that you know the number of sales you need to break even, the next step is tracking your sales. Keeping track of your sales lets you know beforehand if you’re going to have an issue in generating the target revenue. It also helps you allocate money for business operations related to revenue generation. For example, suppose that you know that the number of sales required to reach break-even is 3,000 units. Half the month has passed and you have only sold 1,000 units. Since you’re tracking your sales, you realize how far ahead you are for this month’s sales target. The month isn’t over yet and making more efforts towards the marketing of your products might still get you there. Just make sure that if you’re allocating more money towards marketing your products, the sales generated must exceed the amount spent on marketing.
If you want to track your sales, then one way of doing this is linking Google Analytics to your website. There is even a plug-in available that is specifically designed for eCommerce sites to help you out.
Once you have calculated your sales, cost of goods sold and your expenses, you can now calculate your earnings before tax (EBT). This involves subtracting your cost of goods sold, operating expenses and your interest expense from total revenue.
7. Tax Rates
Next, we have taxes. It is everyone’s least favorite thing, but taxes are both unavoidable and complicated. If you sell different products and services, then it is best to consult a professional in the matter. Make sure to flag products if they are taxable. When a customer purchases it, you’ll need to provide them with a tax payable.
In order to stay organized, it is best if you categorize products according to those that require a tax payable versus those that are exempted from taxes. As you’ll find out in the next portion, keeping track of taxes is very important; otherwise, it can cause trouble down the road.
8. Tax Payments
Your tax payments primarily depend on the physical location of your business. As a starting point, however, you can assume your tax amount to be nearly as much as the tax you have collected from your customers. This means it’s important that you recognize the nature of that money and set it aside as tax and not a portion of your revenue. If you don’t, this could create problems for you when it’s time to make payments.
Mixing the tax amount with the actual price of the product can also make you lose track of the amount of profit you have made. To avoid such problems, you can consider opening a separate account for your taxes.
9. Balance Sheet
So far the things we have discussed either fall under your cash flow statement or your income statement. Now we have the balance sheet. The balance sheet is mainly for tracking the long term health of your company and to see how it is doing. The balance sheet is made by calculating your total assets, total liabilities and owner’s equity. Assets are anything of value that is under the control of your business. This may be cash, inventory, office equipment and/or accounts receivable.
Liabilities are the debts you owe to people. Both assets and liabilities are defined under a long-term and short term basis. Your owner’s equity is the difference between your assets and liabilities.
The balance sheet is important because it provides a bigger picture and can also pinpoint any inaccuracies in your income statement. For example, if your income statement says that you’re earning profits but your balance sheet tells you something else, it is possible that you have missed out on accounting for some expenses.
Remember that your balance sheet is only correct if your assets = liabilities +owner’s equity.
10. Too Complicated? Get Outside Help
In order to achieve long term success in the eCommerce industry, it is imperative that you get your accounting operations up to mark. If having an internal department dedicated to the task feels too expensive, you can consider outsourced accounting as well. This will greatly reduce the cost of having an internal accounting department and get you in touch with a team of experts at a fraction of the price. If your company has crossed $1 million in gross revenue or is getting close to that mark, then it is likely that having a basic Bookkeeper who is only using QuickBooks is no longer sufficient for your operations. Relying solely on accounting software will also prevent you from making real-time financial decisions for your company.
It is also important to remember that as an eCommerce company, your core business is not accounting, and investing time and energy on something you can outsource only distracts you from focusing on your goals. After all, it is your core competencies that will help your business grow.
Having an outsourced accounting team allows you to achieve much more. Your business owners can make better decisions and focus on aspects like business growth, promoting individual excellence and keeping in line with market trends to keep the business afloat. If you would like more information on the benefits of outsourced accounting and help deciding if it is right for you, then we have a complete guide for you. Click here to download it now for free.