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. As an ecommerce entrepreneur, few things are more exciting 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.
Tables of contents:
- What is ecommerce accounting?
- What does ecommerce accounting entail?
- What do ecommerce business owners need to keep track of?
- Accounting methods for ecommerce
- Best ecommerce accounting software
- How to choose the right ecommerce accounting software
- Ecommerce accounting best practices
- Ecommerce accounting FAQ
What is ecommerce accounting?
Ecommerce accounting involves the systematic recording, organization, and management of all financial data and transactions specifically related to the operation of an ecommerce company. It is a specialized subset of small business accounting designed to address the unique requirements of ecommerce providers.
At its core, accounting is the process of tracking and documenting transactions, classifying them as income or expenses. While it may seem straightforward, the terminology used in accounting can sometimes be overwhelming, especially for those new to business finances. To simplify matters, here are key components of ecommerce accounting:
- Purchase order: A purchase order is a legally binding document issued by a client, specifying the quantity and type of items to be purchased, along with the agreed-upon price. Although it does not constitute payment, a purchase order should include payment details. Businesses may use purchase orders to request raw materials from vendors, while clients may submit them to request specific goods or services.
- Sales order: A sales order is a document prepared by the seller (often in response to a purchase order) that outlines the details of a sale. It includes client information, a 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, invoices, and the total amount of expenses yet to be paid or revenue yet to be received.
- Cost of goods sold (COGS): COGS represents the total cost incurred in the production and distribution of a product. It typically includes expenses such as shipping, warehousing, credit card fees, and other costs directly associated with selling products. Overhead expenses like payroll, marketing, software licenses, and office space are not included.
- Ecommerce sales tax: This refers to the tax paid by an ecommerce business to the state in which a purchaser resides. It depends on whether a sales tax nexus exists between the seller and the state, meaning the state has the authority to tax the business. Typically, a nexus is established if the business conducts any economic activity in the state.
What does ecommerce accounting entail?
Like all business accounting, ecommerce accounting includes:
- Basic bookkeeping functions, like managing invoicing, payroll, and balance sheets
- 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, forecasting, 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
Scaling a business is an exhilarating endeavor, and ecommerce accounting plays a pivotal role in this process. It goes beyond being a mere task for business owners; it serves as a means to gather essential information that propels them towards their business objectives.
Ecommerce accounting enables you to analyze various aspects, such as:
- Identifying the most profitable products or services for your company.
- Tracking the changes in your profits over time.
- Assessing your significant expenses and liabilities.
- Identifying opportunities to enhance your profit margins.
Moreover, it provides financial benchmarking that aids in evaluating the success of new ventures. For instance, you can measure the return on investment (ROI) for a marketing campaign. This strategic insight assists in making informed decisions, such as acquiring a competitor or exploring cost-saving options like warehousing in another state. It also helps you anticipate your next busy season and ensure preparedness.
Additionally, ecommerce accounting encompasses generating crucial financial reports, including profit and loss statements and cash flow statements. These reports act as an owner's manual for your business, offering comprehensive insights into the inner workings of your company, consolidated in a single location.
What do ecommerce business owners need to keep track of?
Business accounting involves the meticulous tracking of a company's transactions, inventory, and financial data. This encompasses crucial metrics like cash flow, gross profit, balance sheets, and profit and loss (P&L) statements.
- Cash flow: Cash flow refers to the movement of money into and out of your business. Effective cash flow management ensures meeting obligations and prevents unintended debt.
- Gross profit: Gross profit is a fundamental metric for business operations, calculated as total revenue minus the cost of goods sold. The formula for gross profit is: gross profit = revenue - cost of goods sold.
- Gross margins: Derived from the same data as gross profit, gross margins are expressed as a percentage of total revenue. The formula is: gross margins = (revenue - cost of goods sold) / revenue. For example, if your company generates $10,000 in revenue with $4,000 as the cost of goods sold, the gross profit is $6,000, resulting in a gross margin of 60%.
- Balance sheets: A balance sheet includes three major categories: assets (such as cash, accounts receivable, and inventory), liabilities (including accounts payable, wages, and income tax), and the combined equity of all shareholders.
- Profit and loss (P&L) statements: P&L statements provide a comprehensive view of your business's profitability during a specific period. They calculate total revenue minus all costs associated with operations, including COGS, marketing expenses, payroll, and overhead. A positive figure indicates a profit, while a negative figure signifies 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.
Here’s an example of how cash basis accounting works:
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 differs from cash accounting in that it recognizes transactions when revenues are earned or expenses are incurred, regardless of when the actual payment is made.
The accrual method is primarily utilized by larger companies and necessitates specialized accounting knowledge and a hands-on approach to account management compared to the cash basis method.
While accrual accounting provides a more precise depiction of a company's financial position, it is also more intricate than cash basis accounting. It is the method mandated by generally accepted accounting principles (GAAP).
Here's how it operates:
Accrual accounting offers a more comprehensive view of a business's long-term financial status. However, it can sometimes mislead business owners about the present state of their accounts. For instance, using the example of the coffee-table maker mentioned earlier, she would "earn" $800 as soon as she completes the table, even if her business bank account remains empty.
Here’s how it works:
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. For example, the aforementioned coffee-table maker would “earn” $800 as soon as she finished her table, for example—but her business bank account might still be empty.
Best ecommerce accounting software
Let’s look at the top small business accounting software you can use in your ecommerce business.
QuickBooks Online is a comprehensive cloud accounting software that offers automation across your ecommerce store. It integrates with popular online sales channels like Shopify. This feature eliminates manual entry and the need to cross-check sales and payouts across different stores.
- Seamless integration: Connect your ecommerce platforms and marketplaces with QuickBooks to automatically import sales and payouts, and map them to the correct accounts.
- Smart matching: QuickBooks automatically breaks down revenue, taxes, and fees across your sales channel and maps the payouts with the bank deposits.
- Trend analysis: It offers insights into your sales, revenue, and top-selling products. Run detailed reports on your business performance across different sales channels.
- Tax management: By automating detailed financial breakdowns, QuickBooks helps you maximize your deductions, making tax time easier.
Xero provides cloud-based accounting software for small and medium-sized businesses. It offers a host of money management features including unlimited users, double-entry bookkeeping, and budgeting support. You can also customize your dashboard to review all your ecommerce metrics at once.
- 800+ integrations: Integrates with various third-party applications, including Shopify and Stripe, to enhance its functionality.
- Unlimited users: You can have as many software users as you need, with multiple control levels for different accounts.
- Invoicing and quotes: Provides customizable invoicing template and a feature for creating and sending quotes. It also includes options for automatic reminders, recurring invoices, and the ability to send and receive money from other Xero users.
- Expense tracking: Connect your credit card and bank account directly into the application, categorize your expenses, split transactions, and remember the previous transaction categories you’ve used.
Source: Zoho Books
Zoho Books is a comprehensive platform for managing your bookkeeping tasks and organizing your transactions. It provides a single, secure location to handle your company’s bills and invoices, reconcile bank statements, and control spending.
- Import: The ability to import and organize your existing data to streamline operations.
- Customization: Allows you to tailor sales and purchase transaction templates to suit business needs and reflect your brand identity.
- Automation: Facilitates task prioritization and management of multiple tasks with automated workflows. These include email alerts, field updates, and in-app notifications.
- Document management: Provides a centralized location for all your documents, enabling upload and attachment of documents like receipts to transaction records. Documents can also be emailed directly to your inbox where they are automatically categorized and processed.
How to choose the right ecommerce accounting software
Selecting the optimal ecommerce accounting solution for your store is a significant decision. As you evaluate various options, consider the following factors:
- Integrations: Look for software that seamlessly integrates with your existing systems to automate data transfer, maintain accurate inventory levels, and simplify tax compliance.
- Scalability: Consider your business's growth potential and choose software that offers flexible pricing plans or upgrade options to accommodate your evolving accounting needs.
- Features: Seek out time-saving features such as invoicing, expense tracking, sales tax calculation, payroll management, and multi-currency support to streamline administrative tasks.
- User-friendliness: Opt for software with an intuitive interface that minimizes the learning curve and reduces the need for extensive training for you and your team.
- Customer support: Reliable customer support is invaluable when facing challenges. Prioritize software providers that offer robust support channels such as live chat, phone assistance, and comprehensive knowledge bases.
- Security: Ensure the software prioritizes the security of your financial data. Look for features like two-factor authentication, data encryption, and regular backups to safeguard your information.
- Positive reviews: Explore reviews from other ecommerce businesses to gauge the software's strengths and weaknesses. Platforms like G2 and the Shopify App Store can provide valuable insights.
Ultimately, the best software choice depends on your specific circumstances. Before committing to a particular solution, take advantage of free trials to assess if it meets all your requirements.
Ecommerce accounting best practices
To ensure the success of your ecommerce operation, it is crucial to stay updated on accounting rules and tax regulations specific to your country and state. Even if accounting is not your forte, following a few simple guidelines can help you effectively manage your ecommerce business. Here are some accounting best practices to consider, whether you're running your first or fifth online store:
- Emphasize good bookkeeping: Maintaining balanced books is essential for effective ecommerce accounting. Accurately record all financial transactions, including sales, purchases, income, and expenses. This practice provides a clear understanding of your financial health.
- Automate tasks whenever possible: Leverage technology to automate various accounting tasks. Use software to track sales, calculate taxes, and send invoices automatically. This reduces the risk of human error and saves time.
- Utilize ecommerce accounting software: Numerous accounting software solutions cater specifically to online businesses and integrate seamlessly with ecommerce platforms. These systems assist in managing and reconciling sales, inventory, and expenses.
- Regularly reconcile accounts: Make it a habit to regularly compare your financial records with bank statements to ensure everything aligns. This practice helps identify and rectify errors before they escalate into significant issues.
- Track inventory: Effective inventory management is crucial for ecommerce businesses. Keep track of your stock, monitor what's selling and what isn't. Your accounting software may offer inventory tracking features, or you can consider using a specialized inventory management system.
- Monitor cash flow: Keep a close eye on your cash flow, tracking the inflow and outflow of funds in your business. Positive cash flow indicates a healthy financial situation, while negative cash flow requires swift action.
- Understand sales tax: Sales tax can be complex for ecommerce businesses, especially when selling to customers in different states or countries. Understand your obligations and ensure you collect and remit the correct amount of sales tax.
Simplify sales tax management with Shopify Tax: Shopify Tax provides a convenient solution to oversee your current sales tax obligations from the Shopify admin. It enables accurate collection of the appropriate tax amount at checkout based on product and location-specific requirements. Moreover, it automatically applies rate and regulatory changes as they occur.
By following these best practices and leveraging tools like Shopify Tax, you can streamline your ecommerce accounting processes and alleviate the stress associated with managing sales tax.
Ecommerce accounting FAQ
How do you do accounting for an ecommerce business?
Ecommerce accounting involves accounting for online transactions, which are often paid for with credit cards or other digital payment systems. Unlike traditional retail stores, an ecommerce company must track and reconcile sales, returns, refunds, and payments from multiple sources, such as PayPal and Stripe. Additionally, ecommerce companies must account for and track inventory, shipping, taxes, and other transactional data.
What are the accounting issues for ecommerce?
Ecommerce accounting presents several issues, including managing sales tax liability across different jurisdictions due to the “economic nexus” rules. It also involves the complex task of inventory management that requires tracking the status and location of goods across possibly multiple warehouses or fulfillment centers. Other issues include tracking various seller fees charged by ecommerce platforms, handling product returns and ensuring accurate accounting for them, and limitations in accessing to real-time data analytics, which can hinder proactive decision-making.
What are the benefits of ecommerce accounting?
Bookkeeping and accounting are important for ecommerce businesses for many reasons. First, accurate bookkeeping and accounting are essential for tracking cash flow and understanding the financial health of the business. This information can help guide business decisions and ensure the business stays compliant with all applicable regulations. Furthermore, good bookkeeping and accounting practices can identify areas where the business can reduce costs and increase sales. Finally, by tracking financial information, businesses can better plan for taxes, track customer payments, and manage inventory.
Do I need an accountant for my ecommerce business?
It depends on the size of your ecommerce business. If you are just starting out, you may not need an accountant. However, if your business is growing and you need help with taxes and other financial issues, an accountant may be beneficial.