The challenges and situations faced in keeping the books for an eCommerce software are different from that of a brick-and-mortar store. You need to account for components that don’t necessarily exist in other businesses. To begin with, sales tax calculations for an eCommerce business are very different from a brick-and-mortar store. Furthermore, overseas shipments also need to ensure compliance with international regulations for tax and duties. In addition, shipping expenses are a significant cost for eCommerce businesses. Thus, you need to be well versed in the principles of eCommerce accounting.
Top Ecommerce Accounting Principles Everyone Must Know About
Since various aspects of eCommerce accounting are different from a brick-and-mortar store, having a firm understanding of key eCommerce accounting principles is essential. Here are 6 top eCommerce accounting principles that everyone must know about:
- Startup Accounting
Familiarize yourself with the basics of accounting to build an eCommerce business with its finances and books in place. While eCommerce accounting software automates all the processes like journal entries and financial statements, you need a firm hold over these basics to set it up correctly.
Startup Accounting includes much more than basic bookkeeping procedures. Decisions like whether to choose the inventory accounting method over the cash or accrual basis of accounting are also a part of it. Monitoring the cash flow statement in the early stages of the business is strongly advisable. In addition, regularly completing bank reconciliations goes a long way in keeping your business afloat before sales start rolling in.
- Cost of Goods Sold (COGS)
The cost of goods sold or COGS are the three product costs- direct material, direct labour, and manufacturing overhead.
Direct material cost is the cost incurred to acquire the raw materials for the products. Note that you should also include the taxes and shipping costs that apply to the raw materials. Direct labour is the cost of workers to turn the raw materials into a finished good. Manufacturing overhead includes costs like factory rent, utilities, and supervisory staff costs. It has both fixed and variable elements.
It must be noted that you shouldn’t account for the cost of shipping the products to the customers in the COGS calculation. It needs to be accounted for separately, the reasons for which will be discussed further.
- Monitoring Profitability
eCommerce businesses operate internationally and are thus met with fierce competition. Thus, offering discounts and price slashing become important to have an edge over the competition. But, you need to monitor your profitability before offering discounts or price cuts.
Use the following metrics to monitor your profitability:
- Breakeven Point: The metric tells you the number of products you need to sell to neutralize costs.
- Contribution Margin: This metric measures your products’ profitability after deducting variable costs.
- Gross Product Margin: Gross Product Margin measures profitability after subtracting all product costs, including the fixed component of manufacturing overhead.
- Operating Margin: This metric calculates your business’s earnings after subtracting the expenses incurred in your primary business activities.
- Net Profit Margin: This is the net income of your business, which is calculated after subtracting the non-business expenses and income tax from the operating margin.
Monitoring these metrics on your eCommerce accounting software will allow you to be informed about your products’ profitability. With an informed business budget you’ll be able to create a pricing structure that yields the maximum profits.
- Handling Shipping Costs
Order fulfillment is one of the central processes that you need to streamline to make a successful eCommerce business. When your sales are dependent on shipping products, the processes need to be fast and efficient. Shipping costs are not a part of COGS, being distinct from the product itself. However, it does play a role in the total cost of sales. These costs need to be monitored accurately to decide how much you need to charge for shipping.
- Sales Discounts, Returns, and Allowances
Accounting for sales discounts, returns, and allowances should be your tips for managing an eCommerce business effectively. These adjustments to sales can be recorded by adding two accounts to the chart of accounts in your accounting software- sales discounts and sales returns and allowances. These two charts can further be deducted from your sales number to get net sales.
- Business Tax Reductions
If you have just started to build your eCommerce business, you might not be familiar with the business tax deductions you can take on your tax returns. Unlike individual tax deductions, businesses can avail of tax deductions on most ordinary and necessary business expenses. Find out about the expenses specific to eCommerce businesses that can be deducted from your tax returns. For instance, if you are running your eCommerce business from your home, you can benefit from a home office deduction. There are various other expenses like these that you might be able to avail tax deductions on.
These were the six top eCommerce accounting principles that every eCommerce business owner must know about. The best eCommerce accounting software allows you to implement your accounting strategy effectively by inculcating these principles.