Proper ecommerce accounting is vital to the success of your business. You need to know how to keep accurate records to report and pay your taxes correctly. If you can’t navigate all this properly, you could find yourself in big trouble with the IRS. In this post, we’ll go over the essentials of accounting for ecommerce businesses so you can remain compliant.
Understanding Ecommerce Accounting
Accounting for ecommerce businesses is a specialized branch that caters to the unique needs and challenges of businesses that operate online. Ecommerce accounting deals with additional items that other businesses may not have. For example, you might have online business costs like order shipping fees and payment gateway fees.
Cash flow management can be especially tricky for ecommerce businesses. Keeping accurate records of online transactions can help you tremendously. You can not only ensure you have sufficient funds to cover operational costs, but also invest in growth opportunities.
Key Components of Ecommerce Accounting
Purchase Orders
Purchase orders (POs) are crucial documents for ecommerce businesses. They are used to manage inventory and track expenses related to acquiring the products you sell online. While not a form of payment, they serve as a formal communication between you and your suppliers that outline the purchase details you agreed on.
The typical PO includes:
- Your company’s and the supplier’s information – name, address, contact details.
- A unique PO number that identifies the order for tracking purposes.
- The order date.
- Details of the products being ordered, including descriptions, quantities, and unit prices.
- Delivery information like the desired delivery date and shipping address.
- The payment terms you and the supplier agreed to follow, including the method and due date.
- Any additional terms you want to track, like product warranties or return policies.
Detailed purchase orders help you to make sure to order the correct products to meet customer demands. They also give you a record of item pricing so you can track costs and calculate profit margins. When you know your upcoming purchase obligations, you can forecast expenses and manage ecommerce cash flow more effectively.
POs also establish a clear communication channel with suppliers. They can serve as legal records of purchase agreements, too. When you want to negotiate discounts with suppliers, having a record of all your POs can strengthen your negotiation position. Many accounting software solutions integrate with inventory management systems and allow you to generate POs electronically. This streamlines the process and reduces errors.
Sales Orders
Sales orders (SOs) are internal documents you can use to confirm a sale with a customer. They don’t involve any financial transactions themselves, but are crucial for tracking sales and fulfilling orders.
The typical SO includes:
- Your company’s information – name, address, contact details.
- The customer’s information – name, address, contact details, billing and shipping address.
- A unique SO number that identifies the order for tracking purposes.
- The order date.
- Details of the products being ordered, including descriptions, quantities, and unit prices.
- The total amount payable by the customer, including any applicable taxes or shipping fees.
- The payment terms the customer agreed to, including the method and due date.
- Delivery information like the desired delivery date and shipping method.
- Any additional terms you want to track, like discounts offered to specific customers, product warranties, or return policies.
Accurate sales orders help you maintain a clear record of the details of products you sold to each customer. This helps with picking, packing, and shipping items accurately. SOs also establish clear communication with customers about their purchases. Together, this can significantly improve customer satisfaction.
SOs help you track inventory levels and identify which products are selling well. This is valuable data for analyzing sales trends and customer behavior. Your ecommerce platform might automatically create SOs as soon as customers pass checkout. It usually goes through your inventory management system to verify stock availability and initiate the fulfillment processes. Once the order ships, the SO status gets updated in your accounting system, which generates a sales invoice for customer billing.
Accounts Payable and Receivable
Accounts payable (AP) and accounts receivable (AR) track the flow of money related to buying and selling products. They represent opposite ends of a transaction cycle and are crucial for understanding your business’s financial health. AP represents the money your business owes to suppliers or vendors. This is because an ecommerce business will usually purchase products on credit, payable after a set period.
In most software, your POs will generate AP entries in the accounting system. AR, on the other hand, represents the money that your customers owe you for products they purchased on credit. Usually, this happens with credit cards with delayed capture. Your SOs confirm these sales and initiate AR entries in the accounting system.
Cost of Goods Sold (COGS)
The Cost of Goods Sold (COGS) is the direct cost of the products you sell online. By subtracting COGS from your sales revenue, you get the gross profit, a key indicator of your business’s profitability. It’s a crucial metric for analyzing the business’s financial performance, too.
Gross profit margin is a profitability metric that represents the percentage of sales revenue remaining after accounting for the COGS. A higher gross profit margin indicates a more significant profit per sale. By comparing COGS to your selling prices, you can assess your pricing strategies. As you identify areas for potential cost reductions, you can optimize your pricing to maintain profitability and competitiveness.
Ecommerce Sales Tax
Ecommerce sales tax is the tax levied on the sale of digital or physical products sold online. The online nature of ecommerce sales can introduce challenges in determining sales tax collection and remittance responsibilities.
A sales tax nexus is a legal connection that establishes a seller’s obligation to collect and remit sales tax in a particular state. Traditionally, the government determined nexus according to a physical store, warehouse, or employees in a state. This is a unique complexity for ecommerce businesses. Many states now have economic nexus laws that govern when sellers must collect and remit sales tax. There’s a certain sales threshold or number of transactions set within a state, regardless of physical presence.
In any case, sales tax rates vary by state and even at the local level. This means that ecommerce sellers usually collect and remit sales taxes at different rates because they have customers in various locations. Similarly, the taxability of products can vary by product category and state regulations. Certain items, like clothing, might be taxable in one state but exempt in another.
Despite the increased complexity for ecommerce businesses, online sellers must accurately calculate and collect the appropriate sales tax for each product and order. Sellers are generally responsible for filing periodic sales tax returns with the relevant state and local tax authorities. Accounting software solutions that can automate sales tax calculations and filing processes can be very helpful.
Challenges in Ecommerce Accounting
Handling High Volume Transactions
A high volume of transactions can put a strain on systems and lower store performance. Slower processing times can frustrate customers, which is never good. The strain can also increase the risk of system outages. Complete disruptions in service can lead to significant downtime and lost sales opportunities.
When your fulfillment capabilities are strained, picking, packing, and shipping can become a logistical challenge. The same is true for customer service, causing teams to struggle to keep up with inquiries, complaints, and order tracking requests. These are additional chances for frustrating delays that negatively impact customer satisfaction.
With high volumes, data errors can also creep in more easily. This can mean incorrect inventory levels and billing mistakes. Stockouts can occur if inventory is not replenished quickly enough, disappointing customers. You want to avoid accounting mistakes at all costs or face the consequences of failing to maintain accurate accounting.
Another area for real concern is the potential for an increase in fraudulent activity when things are extremely busy. Without robust security measures, the chaos can allow fraudulent orders to slip through. Cash flow concerns are equally important. Properly managing a large influx of payments and ensuring timely payouts to suppliers can become difficult.
Managing Multichannel Sales
Multichannel sales are a great way to expand your reach and boost sales. However, this introduces complexities to your accounting processes. When you have multiple sales channels, you must track inventory levels in real time to maintain accuracy. This means investing in a centralized inventory management system. This is how you can manage to synchronize stock levels and get updated levels across all channels when each sale occurs. You can understand how vital this is when you move high volumes, too.
Don’t forget to regularly analyze and reconcile inventory and sales data across all channels. You need to keep detailed records to make sure that your accounting is precise. Investing in accounting software designed to handle multichannel sales can be very helpful.
Dealing with International Currencies
International sales can present a unique set of hurdles as you manage different currencies. When processing international transactions, know that the values of currencies constantly fluctuate. These fluctuations can significantly impact your accounting if you don’t keep track of the exchange rates. You also need to take into consideration the fees, processing times, and exchange rates specific to different international payment methods. These multiple calculations for different transactions can also increase the risk of accounting errors.
Different countries have regulations governing foreign exchange transactions. You must stay informed and compliant with these regulations to avoid legal issues and penalties. Selling products or services internationally can have tax implications in both your home country and the countries you sell to. Although you can do your own thorough research, we recommend consulting with tax professionals to ensure you comply with all applicable tax laws.
Platform Fees and Payment Gateways
Ecommerce platforms and payment gateways also charge transaction fees and use their own exchange rates. Make sure you are calculating and reporting your income based on the correct transactions as reflected by these processors.
You can account for these fees as part of your COGS as a direct cost of generating revenue. This is because you incur these fees to facilitate your core business activity. You can also consider the fees as general business operating expenses. You can then group them with other ongoing costs like rent, utilities, or salaries in your income statement.
Shipping and Handling Costs
Shipping costs fluctuate significantly based on the weight, dimensions, and destination of your products. Make sure you accurately record these costs so that you can maintain accurate expense tracking. This will prevent you from overpaying on your taxes.
Main Tasks in Ecommerce Accounting
Tax Accounting
Whether you need to collect, file sales tax, and manage VAT/GST for international sales depends on several factors. Like sales tax, you generally only need to collect VAT or GST if you have a physical nexus in a specific jurisdiction. If a country has economic nexus laws, however, you need to understand your corresponding obligations.
Thresholds, rates, exemptions, registration requirements, and regulations vary significantly, and can be very complicated to learn. Non-compliance can lead to penalties, interest charges, and even business license revocation in severe cases. Therefore, you must not make mistakes. We recommend that you hire a professional accountant to make sure your business stays updated on the ever-changing tax landscape for international ecommerce.
What Is EcomBalance?
EcomBalance is a monthly bookkeeping service specialized for eCommerce companies selling on Amazon, Shopify, Ebay, Etsy, WooCommerce, & other eCommerce channels.
We take monthly bookkeeping off your plate and deliver you your financial statements by the 15th or 20th of each month.
You’ll have your Profit and Loss Statement, Balance Sheet, and Cash Flow Statement ready for analysis each month so you and your business partners can make better business decisions.
Interested in learning more? Schedule a call with our CEO, Nathan Hirsch.
And here’s some free resources:
- Monthly Finance Meeting Agenda
- 9 Steps to Master Your Ecommerce Bookkeeping Checklist
- The Ultimate Guide on Finding an Ecommerce Virtual Bookkeeping Service
- What Is a Profit and Loss Statement?
- How to Read & Interpret a Cash Flow Statement
- How to Read a Balance Sheet & Truly Understand It
Conclusion
Ecommerce regulations can be intricate and can change frequently. Staying informed about the latest rules in the states you operate in is essential for ensuring compliance and avoiding penalties. By effectively managing your ecommerce obligations, you can maintain a good standing with tax authorities and streamline your accounting processes.
