Ecommerce accounting is quite different from the traditional bookkeeping brick-and-mortar sellers practice. So it’s critical to understand a set of core building blocks to get the full picture of your business’ financial performance.
Why? Savvy online retailers know that having a solid grasp of ecommerce accounting basics plays a huge role in accumulating relevant data about a store’s fiscal health and fueling growth.
Leveraged wisely, these basics of accounting can set your operation on the path to long-term success. From tracking cash flow to collecting and validating sales tax, you’ll continually use these tenets throughout the life of your business. And, when applied strategically, they’ll give you insights to sustainably scale while avoiding the most common accounting errors.
Review common accounting terms, GAAP, and the accounting cycle for business owners, applicable whether you sell online with a physical inventory, sell online without inventory (via digital goods or dropshipping), or in person through a POS terminal.*
Introduction to accounting: 32 basic accounting terms for small businesses
- Accounts payable: Every bill your business owes, excluding payroll.
- Accounts receivable: Every invoice owed to your business for products or services rendered.
- Accrual accounting: An accounting method that records income and expenses when they're billed.
- Assets: Tangible and intangible resources or property you own, including inventory, cash, investment, and machinery.
- Balance sheet: A financial statement that outlines what your business owes and owns; a snapshot of your financial position.
- Break-even point: The point in time at which you earn as much as you owe.
- Cash flow: Money in and out of your business at any time.
- Cash flow statement: A financial document that shows the changes between cash in and out in a given period.
- Capital: The money you have to pay for operating expenses, also called "working capital."
- Cash accounting: A method of accounting that records income and expenses when you receive or make payments.
- Chargeback: Funds transferred to customers from your merchant account due to a purchase dispute.
- Cost accounting: An accounting process that records a business's total cost to produce goods and services, including fixed and variable costs.
- Costs of goods sold: The total amount you pay out of pocket to produce goods for sale, including shipping, packaging, manufacturing, labor, and commissions.
- Debits and credits: Records of money going out and coming into the business; typically, for every debit recorded, there's a credit of equal value.
- Depreciation: The value an asset loses over time.
- Dividends: The amount your business owes to stockholders or shareholders.
- Double-entry accounting: A financial accounting that records debits and credits of equal value.
- Equity: The difference between a business's assets and liabilities.
- Expenses: The costs your business incurs to operate, including fixed, variable, accrued, and operational expenses.
- Fiscal year: The 12-month period your business uses for financial reporting, which doesn't have to start in January.
- General ledger: The place where you keep the business's financial accounts, often accessible via accounting software.
- Income statement: A financial document that outlines your business's gains and losses for a given period; also called a profit and loss (P&L) statement.
- Inventory: The items in your catalog for sale on hand or through a third party.
- Invoice: A record of charges for goods and services you send to customers, vendors, and contractors.
- Journal entry: A summary of financial transactions. Journal entry accounting records financial transactions as summaries in an accounting system.
- Liabilities: Your business's debts, including accounts payable.
- Profit: The money you keep after money earned exceeds money paid, not to be confused with profitability.
- Profitability: A measure of a company's capacity to make money relative to its expenses or investments.
- Reconciliation: The process of comparing transactions to financial records, also called "closing the books." You may use accounting software to simplify this process.
- Revenue: The total money generated selling goods and services before expenses.
- Remittance: The act of sending all collected sales tax for ecommerce to the appropriate state or local jurisdiction.
- Transaction: Any financial action that takes place in your business.
10 generally accepted accounting principles (GAAP)
Small business owners and their accountants or bookkeepers are subject to 10 generally accepted accounting principles (GAAP).
- The principle of regularity affirms your agreement to adhere strictly to the 10 principles.
- The principle of consistency affirms your accounting methods are always consistent and comparable.
- The principle of sincerity affirms your commitment to accuracy and staying impartial in the accounting process.
- The principle of permanence of methods affirms you'll generate financial reports the same way.
- The principle of non-compensation affirms that you'll fully report the business's performance with no prospect of debt compensation.
- The principle of prudence affirms you'll enter all financial transactions in a timely and realistic manner.
- The principle of continuity affirms you assume business operations will continue.
- The principle of periodicity affirms you'll report revenue by standard accounting periods, either quarterly or every fiscal year.
- The principle of materiality affirms you'll fully disclose business performance.
- The principle of utmost good faith affirms you'll act honestly in all financial reporting.
Accounting 101: The accounting cycle for online and in-person sales
There are eight basic steps in the accounting cycle for businesses of all sizes. Considerations for each step increase for online sellers, especially those that sell on several channels or in person at a POS terminal. Ideally, businesses complete this cycle every 30 days. Many resources, including this one, assume businesses use accounting software like QuickBooks Online or QuickBooks Desktop for each step.
1. Identifying transactions
The first step of the accounting cycle will have you identifying every business transaction from the last month. Transactions include sales made and bills paid. If you sell on a marketplace or incur other expenses and fees monthly, include those in your search.
2. Recording transactions
Your accounting method will decide when to record transactions (i.e., at the time of transaction or payment). Regardless, you'll need to create a journal entry for each transaction.
3. Posting transactions
Now, you'll want to post or add every journal entry to your general ledger account. Your general ledger may include different accounts for assets, liabilities, equity, expenses, and revenue.
If you use accounting automation software that connects your online store and POS system to your accounting solution, you can complete this step automatically and eliminate the need to complete it manually.
4. Generating an unadjusted trial balance
Once you've posted all your transactions, it's time to generate an unadjusted trial balance. This trial balance will help you see if your total debits and credits are equal. If your balances are the same and you're confident in your work, you may move on to step seven.
5. Adjusting entries
If your unadjusted trial balance isn't equal, your records may have errors or discrepancies. Carefully review each journal entry against each transaction to identify transposition, reversal, or duplication errors.
These errors are common if you're managing your books in spreadsheets or manually entering a lot of information. Adjust entries to correct errors as you find them.
6. Generating an adjusted trial balance
Generate a new trial balance. The adjusted trial balance should show equal debits and credits.
7. Generating financial statements
You can use that data to generate financial statements now that your books are balanced. For most businesses, these include your income statement, balance sheet, and cash flow statement.
8. Closing the books
Closing your books confirms you're done adjusting entries for a given period. The more consistently you close your books and begin the accounting cycle over, the better, especially if your business is subject to hundreds or thousands of transactions.
Experts suggest completing the cycle monthly or, more accurately, every 30 days. If you sell on a marketplace, there's a good chance you won't receive all of the current month's payouts by the last day of the month. So closing the current month's books might happen after the first two weeks of the next month.
10 online accounting basics for business owners
1. Learning the difference between cash and accrual accounting
Cash accounting is simple. Any money coming in is considered income, and money going out is an expense. This method is the most elemental form of accounting and is perfect for tracking simple cash flow.
However, ecommerce accounting operates a bit differently, which is why online retailers should also be familiar with accrual accounting. The accrual method counts income and expenses when the transaction occurs rather than when the payment is made. And it's more beneficial for inventory-based businesses.
Sellers need to track revenue at the time of each sale, not when they collect money. This type of accounting will help you visualize the long-term impact of your business’s cash flow.
2. Tracking cash flow
Perhaps the most important performance indicator to monitor is your business’s cash flow or the way money moves in and out of your business. Seems simple, right? Think again.Most ecommerce platforms and online marketplaces only provide cash flow reporting every few days or weeks via payouts and settlements.
So sellers and accountants need to integrate these channels with technology that helps them visualize business analytics in real time. Cash flow should include any auxiliary costs, holds on incoming revenue, and other factors.
3. Counting inventory
Another fundamental ecommerce accounting principle to understand is the basics of inventory counting. Many costs get folded into inventory, such as materials, manufacturing, packaging, storage, shipping, and more.
Part of maintaining positive cash flow is acquiring a breakdown of all costs, but it doesn’t stop there. Be sure you know the value of the products you’re selling, how many you're selling compared to how many you're producing, and where you can access a thorough count of what’s in stock at any given time.
4. Knowing the costs of goods sold
Cost of goods sold (COGS) refers to the amount you spend to produce your products, including material, labor, distribution, and other associated costs. It’s critical to calculate these expenses before listing products in your online store to price them strategically for maximum profitability.
The right accounting automation software can automatically track all of this for you, providing your business with accurate financial data every step of the way.
5. Calculating your expenses
Your business expenses include everything from overhead — utilities, storage, property expenses, inventory costs, etc. — to marketplace fees for Amazon, Etsy, and eBay and ecommerce platform fees for Shopify and BigCommerce.
Some expenses, such as rent and priority mail shipping, are fixed, while variable expenses fluctuate throughout the year. Variable expenses can drastically affect your cash flow.
You should always factor any dramatic changes to things like business development costs or advertising budgets into your overall expense calculations. Overall, organizing your business expenses is essential for identifying tax deductions.
6. Finding your break-even point
If your business is making a consistent profit, great! But don't get too comfortable. Get to know your break-even point to stay ahead of the game and ensure you operate at a comfortable profit margin. At this point, the dollars you earn fully cover the dollars you spend.
If your operating expenses are too high while incoming revenue is too low, you’ll fall short of your break-even point and fail to generate profit. While this imbalance might occur temporarily while you ramp up your operation, your business cannot remain viable if it becomes a long-term problem.
7. Determining your gross margin
Your break-even point and COGS are also tied to your gross margin, which is calculated by subtracting the cost of goods sold from your sales revenue. The higher your gross margin, the more of each dollar you retain to use for anything from debt repayment to marketing your business. Therefore, it's much easier to be profitable in the long term if you keep your company's overhead expenses within reason.
8. Meeting sales tax requirements
It can’t be overstated that even a simple understanding of the ever-changing sales tax requirements for ecommerce businesses is a huge advantage. Because ecommerce retailers don’t operate like traditional stores, the tax burden changes from state to state.
Combining your knowledge with the best accounting software and the help of an ecommerce accounting professional can propel your business into even more success.
9. Generating profit and loss statements
Profit and loss statements (P&Ls) show a snapshot of your business within a certain period by summarizing income and expenses. They're also referred to as income statements or earnings statements.
The data on a P&L gives you an accurate view of how your business is doing from month to month and quarter to quarter and includes data regarding your gross margin, operating expenses, and profits. You'll also reference your P&Ls when working with an accounting professional, as well as your balance sheet and cash flow statements.
10. Analyzing your balance sheets
Once again, keeping meticulous accounting records will show you a broad view of your business’s overall growth. A balance sheet shows your business’s assets, equity, and liabilities.
Consider it this way: While your P&L offers a snapshot of your business at a particular moment, your balance sheet showcases the bigger picture. These two documents come together to paint a detailed picture of your business’s financial health in the short and long term.
Conquer the basics with an accounting solution
If your head is spinning by now, don’t worry. Accounting is a complex process, but it gets easier once you have a handle on the basics. Another trick to simplify your accounting? Digitize it with software like QuickBooks so you don’t have to dig through a shoebox of receipts every time you want to see how your money is moving.
By aggregating your data in one place, you’ll always be accurately informed about what’s going on on the financial side of your business. Overall, practicing these basic accounting principles can strengthen your business, making your company more profitable and helping your products reach more people. A little extra knowledge goes a long way in ecommerce.
*This content is for information purposes only and should not be considered legal, accounting, or tax advice, or a substitute for obtaining such advice specific to your business. No assurance is given that the information is comprehensive in its coverage or that it is suitable in dealing with a customer's particular situation. Webgility Inc. does not have any responsibility for updating or revising any information presented herein. Accordingly, the information provided should not be relied upon as a substitute for independent research. Webgility Inc. does not warrant that the material contained herein will continue to be accurate nor that it is completely free of errors when published. Readers should verify statements before relying on them.