Every online business owner needs to keep tabs on how the business is performing financially. This is possible through efficient bookkeeping services. Keeping accounting records will allow you to easily pull up data to know about the financial position of your company.
In this blog guest, you will know accounting best practices for online businesses. You will know how to maintain an accurate financial record of your e-commerce website. You will also know tax accounting tips that will prove invaluable when it’s time to file returns.
Note: After reading this comprehensive guide, you can decide for yourself whether to do accounting for your e-commerce business yourself or hire outsourced bookkeeping services
Ecommerce Accounting vs Bookkeeping: Know the Difference
You must have a clear understanding of eCommerce accounting and bookkeeping. This is important when outsourcing the task of preparing financial records.
Bookkeeping refers to the accounting practice of recording financial transactions. The following are the key tasks in bookkeeping.
- Categorizing Transactions
- Preparing invoices
- Bank reconciliation
- Payroll
- Maintaining chart of accounts
Accounting is different from bookkeeping as it involves the analysis of financial records that are prepared by a bookkeeper. It involves preparing financial statements to know about the current financial position of your company. In addition, you can use the information to plan for future activities.
The key accounting activities include the following.
- Creating adjusting entries
- Preparing income statement, balance sheet, and cash flow statement
- Audit of financial transactions
- Tax preparation and submission
- Financial risk analysis
- Financial projection
Accounting aims to prepare financial reports that will let you make strategic business decisions. The financial reports must be prepared by expert accountants. This is important since errors in the statement will result in making the wrong financial decisions.
Why Bookkeeping and Accounting are Necessary for eCommerce Firms?
Bookkeeping and accounting are essential for online businesses. The activities create a platform for creating a financially stable business.
Keeping accurate financial records is important whether you sell products or services through Amazon, Shopify, Etsy, or BigCommerce. Here are some solid reasons for eCommerce firms to focus on accurate accounting and bookkeeping tasks.
1. Help You Make Sound Financial Decisions
Bookkeeping and accounting will let you make timely financial decisions. It will let you build a foundation for effective decision-making to ensure the sustainable operation of the business. You can make accurate projections about the future financial performance. This will allow you to effectively manage your business.
2. Help You Create a Reliable Business Model
Bookkeeping will help in creating a system for recording income and expenses so that you get a clear insight into the financial performance of the business. You will know what products to add to your portfolio to boost profitability. It will also let you know operational expenses that can be cut down to improve the profit position of the company.
When you create financial statements, you will know how much is due from customers and payable to vendors. The activity will allow you to better plan your online business.
3. Preparation of Tax Returns
A solid process of bookkeeping and accounting will help in preparing tax returns. When you regularly record expenses and income using accounting best practices, you will have an easier time in gather financial information for tax purposes.
Moreover, you can work with your accountant to reduce taxes. You can know about deductions that will let you minimize the tax amount due.
The earlier you prepare for taxes, the less stress you will feel when it comes to submitting a tax report. It will ensure that you don’t scramble to collect supporting documents related to payments and receipts. You will have all the documents organized when you have a solid bookkeeping and accounting process.
4. Getting Financial Support
Keeping accounting records will help in getting funds from third parties. Creditors and investors will be looking at financial statements before making a decision. Securing funds will be easier when you create accurate financial statements.
Make sure that your financial statements are made by professional accounting or bookkeeping service providers. Inaccuracies in financial statements will make it difficult for you to secure funds for your online business.
5. Efficient Cash Flow Management
Preparing accurate financial accounts will ensure that you don’t face cash shortages. A cash flow statement will help you project whether you will have enough cash to meet financial obligations during a period.
With increased competition, online businesses face challenges in remaining profitable. The margins are getting smaller due to the increasing number of online sellers. You can outcompete and remain stable by implementing aggressive cost-cutting measures. In this regard, the information from bookkeeping and accounting tasks will help in making quick adjustments to ensure efficient operations.
Things You Need for Accounting/Bookkeeping of Your Ecommerce Website
You will need to have the following things to ensure the smooth accounting of your online business.
1. Accounting Application
An accounting application is important for recording online business transactions. Using an accounting app will save you a lot of time and effort in keeping accounting records. It will save you a lot of hassles in income and expense tracking and accounting report generation.
Some of the popular accounting apps you can use for recording accounting information for your online business include:
- QuickBooks Online
- Freshbooks
- Xero
- Sage
- Kashoo
2. Dedicated Business Account
You must create a dedicated business bank account for your online business. It is advisable not to mix personal and business bank account as it will create accounting problems.
3. Businesses Tax ID
Registered businesses will have to apply for a business tax ID that will be required when you file tax returns. You must submit an application with the IRS for an Employer Identification Number (EIN). Every business is issued a unique 9 number EIN that must be used in all tax documents.
An Overview of Accounting Best Practices for Online Business
Here are key accounting tasks you need to perform to record financial-related data of your online business.
- Select an accounting method
- Create a chart of accounts
- Record income and expenses
- Keep track of inventory
- Record account receivable and payable
- Keep track of payroll taxes
- Create financial statement
- Calculate tax due
- Prepare cash flow statement
- Create business budget
1. Select an Accounting Method
Before you get started with accounting for your online business, you must decide on the accounting method for the record of income and expenses.
The two accounting methods that you can use to record transactions include accrual basis and cash basis. You must choose wisely since changing the accounting method later down the road will be difficult.
Accrual Accounting Method
The accrual basis accounted method involves recording income and expense at the time when it occurs. The accounting entries are made as soon as an income or expense occurs rather than when cash is received or paid.
Let’s take a look at a simple example to help you understand the accrual base method.
Suppose that you made a purchase valued at $2000 on credit on June 20th. You make the payment to the vendor 30 days after purchase. With the accrual based, you record expenses on June 20th when the expense has occurred.
Accrual based accounting method is a traditional method that is most commonly used by businesses. The accounting method provides an accurate picture of the financial position of the company. It helps business planners make realistic financial projections.
Accrual based accounting is recommended for the following businesses
- Registered businesses (C-corporation, S-corporation, etc.)
- Online businesses with high inventory
- Companies with multiple suppliers
- Intend to apply for a loan
Accrual based accounting method requires recording expenses and income when they occur. It doesn’t matter whether the cash payment is made or received. With this method, you record the amount due that you haven’t received (account receivable) or haven’t been paid (account payable).
This method is recommended for companies that rely on external financing. Investors and creditors require that the accounting statements are prepared using the accrual based method. The reason they prefer accrual-based accounting is that it provides a more realistic reflection of the financial condition of a company. In addition, it allows stakeholders and management of the company to make more accurate financial projections.
With the accrual-based accounting method, your focus shifts from your cash balance to the profitability of a company. The method includes prepayments and the amount due in the future.
Cash Accounting Method
The cash accounting method involves recording income and expenses on cash payment or receipt. The method is simpler than the accrual accounting method. But it does not show an accurate projection of the financial position of a company.
Here is a simple example that will help you understand the cash based accounting method.
Suppose that you made a purchase valued at $2000 on credit on June 20th. You make the payment to the vendor 30 days after purchase. With the case accounting method, you record expenses on July 20th when you make payments.
For tax purposes, the cash accounting method is not allowed for companies with an annual turnover of $5 million or more.
Cash based accounting is recommended for the following businesses
- Amazon FBA stores
- Small online stores
- Products procured on-demand
- Dropshipping business
With the cash basis of accounting, a new record is added whenever a cash payment is made or received. The book will reflect the cash received from customers and paid to vendors and other entities. It will mirror the information in your bank account statement.
Cash based accounting methods are suitable for small online business owners. The reason is that maintaining records using this method is simple and easy. You have to only record when enter and leave your bank account. It will let you know the cash amount that is available for the business.
The accounting method is not recommended for large eCommerce owners. The reason is that it doesn’t recognize account receivables or payables. You will have to prepare a separate account to know about the amount due.
2. Create a Chart of Accounts
A chart of accounts categorizes expenses and income into categories. This will simplify the task of recording expenses. Creating a chart of accounts will make it easy for you to organize business transactions.
A chart of accounts should contain the following information.
- Name of transaction
- Type of transaction
- Description of category
Most accounting software already contains a default list of accounts. You can use the default list of accounts or create your account.
Once you have created a chart of accounts, you should move to the next step of generating financial records.
3. Record Income and Expenses
Once you have created a chart of accounts, you are ready to record the income and expenses of your online business. You must record how many items you have purchased and sold.
Businesses that manufacture or process and sell products online must also consider the cost of goods sold. The cost of goods sold involves expenses incurred in making the products ready for sales. These include the cost of labor, materials, and overhead expenses.
4. Keep Track of Inventory
Keeping track of inventory is also an important accounting task. You should also keep track of items left in stock using accounting software. The factors that determine the value of inventory include the following.
- Purchases: You should record how many purchases you have made during a period.
- Sales: You must record how much you have sold during a period. Keeping track of sales data will let you know how much inventory is sold.
- Returns: You should also record product returns.
Tracking the above accounts will let you know the inventory value. It will let you know the turnover rate which is an important performance metric for online businesses.
5. Record Accounts Receivable & Payable
Accounts receivable and payable are two important accounting concepts. When you buy goods on credit, you must create accounts payable. In contrast, when you sell goods on credit, you create an account receivable.
Keeping track of accounts receivable and payable was time-consuming in the past. Today, you can use accounting software to keep track of these accounts. The online accounting software saves a lot of time and hassles in maintaining receivable and payable accounts.
6. Keep Track of Payroll Taxes
Keeping track of payroll taxes is an important accounting activity for most businesses. An accounting app can be used to record payroll taxes. You should use an app that supports payroll taxes. Using the software will make it easy to know about the exact payroll taxes due to the IRS.
7. Create Financial Statements
Financial statements are important for all types of businesses including eCommerce firms. It is important to follow generally accepted accounting principles (GAAP) when preparing financial statements.
GAAP accounting standards were developed by the Financial Accounting Standards Board (FASB). As per the standards, eCommerce owners should match expenses with revenues when preparing income statements.
Income Statement
An income statement reflects your e-commerce company’s financial performance over a period of time. The document downs the difference between all expenses and income.
Preparing an income statement helps you monitor sales trends and prepare budgets. You will know about key performance indicators (KPIs) such as gross profit margin, cost of sales, cost of goods sold, and net profit margin.
Balance Sheet
Another important financial statement that eCommerce website owners should prepare is the balance sheet. It consists of your current and long-term assets, capital, and liabilities. Current assets include cash and account receivable while long-term assets include items such as furniture and fixture and land.
Current liabilities include loans that are due within a year. These include account payables, taxes payable, and short-term debts. Long-term liabilities are amounts that are due after a year.
In addition, the balance sheet consists of capital invested in the business. The total amount of assets must match the total amount of capital invested and liabilities.
Looking at the balance sheet, you will know about the long-term financial position of your company. It will allow you to know how your online company is financially in a particular period.
Cash Flow Statement
The third important financial statement that every eCommerce business owner must prepare includes the cash flow statement. Preparing the statement is particularly important if you rely on external financing. Looking at the cash flow statement will help you know about the amount of cash available during a period.
With the right online accounting software, you can easily prepare financial statements. The software will prepare the statements for you. Using online accounting apps will automate the task of cash flow preparation. The statement is prepared based on the financial information that you add regarding your online business. The apps will save you a lot of time in determining the cash flow position of your company.
8. Calculate Tax Due
Every company must pay taxes on income earned. You should check your state and federal tax rates before creating a tax report. The tax statement should include all revenue and deductible expenses. It is important that you correctly list revenue and deductible expenses. Entering false information will result in a penalty.
Most accounting software consists of the tax column. You should enter the correct tax rate and the software will calculate the tax due.
If you have signed up for an Amazon Business Seller account, Amazon will charge and collect sales taxes for you. It will also automatically determine if the sales tax on an item is destination or origin-based.
9. Prepare Cash Flow Statement
A cash flow statement is important to know how much money comes in and where your money goes. You must list all cash receipts and cash payments when preparing a cash flow statement.
Consider recording how much you have paid in the following categories.
- Supplier payments
- Inventory
- Packaging and handling
- Transportation
- Payment processing
- Bank charges
- Software subscriptions
- Marketing expenses
- Website hosting
- Taxes
- Product returns and refunds
The total expenses will be deducted from the gross receipt and opening cash balance to arrive at the closing cash balance figure.
Remember that businesses’ income is not fixed and fluctuates due to seasonality, demand changes, and other reasons. You may have negative cash flow in some months where you earn less than expenses. In such a case, you can take the business line of credit to make up the difference between cash inflow and output. You can repay the loan when there is a positive cash flow.
10. Create a Business Budget
You must maintain an eCommerce budget to estimate future expenses and income. The benefit of creating a budget is that it will let you plan your expenses. You will know when to make the capital investment or take a loan.
With a budget, you will remain focused on the long-term financial position of your companies. It will let you set goals and work towards achieving the goals. You can look at historical data from the income statement to know if your business is growing or going in the opposite direction.
You can make different types of budgets based on the worse case, moderate, and best case scenarios. This will let you plan business activities more efficiently to ensure sustainable operations.
Conclusion
A systematic record of accounting information is essential. You must keep an accurate record of the financial information. You must categorize accounting transactions based on income, expense, asset, or liability. Categorizing business transactions helps in the preparation of accurate financial statements.
You can perform the eCommerce accounting task yourself or hire an outsourced bookkeeping service provider to get the job done for you. Getting the help of a professional will save a great deal of time and headache in recording financial transactions.
Whatever route you take, you should review the financial documents regularly. This is important so that you take appropriate actions to handle the financial well-being of your online company.
Maxim Liberty provides professional accounting services to companies. We charge affordable bookkeeping fees for eCommerce website owners. Our professional accountants can handle all the tasks of recording financial transactions for your company. They are well versed in eCommerce accounting and bookkeeping tasks.