Accounting matters for every business. But e-commerce founders and finance leaders face some unique challenges, given the various difficulties of inventory management, logistics, online payments, and handling customer returns. A survey by e-commerce consultancy A Better Lemonade Stand showed 17.7% of founders in the sector struggle with accounting, finance and legal matters for their business.
Rising costs are becoming a real challenge too. Shopify’s recent Future of Commerce study revealed the average shipping container now costs more than $10,000, a four-fold increase from 2021. We bet you’d much rather focus on maximizing your product sales and increasing the overall profitability of the business instead of thinking about accounting and bookkeeping. But if you’re reading this, it probably means you’ve got a question or a problem related to managing your finances.
Let’s start with a quick definition of e-commerce accounting, clear up any potential confusion about the difference between accounting and bookkeeping, and then give you some useful e-commerce principles that can help you better understand your business’s financial situation.
What is e-commerce accounting?
E-commerce accounting is about collecting, analyzing, organizing, and reporting the financial data for your online retail business. Whether you’re set up to sell a growing product range to consumers, to dropship products made by a third party, or recruit shoppers to a limited range of subscription products, you need to manage the business’s finances.
Accounting vs bookkeeping
When you have an accountant, they’re in charge of analyzing, evaluating, and reporting on company finances for tax purposes. A bookkeeper is responsible for recording the company's financial transactions. Good bookkeeping is crucial because it helps accounting interpret financial data and give advice about your tax liabilities.
Get to know these 7 useful e-commerce accounting principles
1. Break-even point
Break-even point (BEP) is when your income is sufficient to pay all your expenses for a given period of time. “Generally, it’s calculated by taking known figures, such as static expenses like rent and payroll, and a figure for unexpected expenses. The total will be your goal for sales income to just break-even,” says Sally Balson, of Balson Bookkeeping Company.
2. Cost of Goods Sold
Finance folks call this COGS. These are expenses directly related to generating your sales, explained Balson. “For example, if you sell apple turnovers, your COGS are: the apples, flour, sugar, and other ingredients plus the payroll costs for the baker,” she said. Your rent, utilities, and office supplies, are not directly related to the sales and are general expenses excluded from COGS.
- A high COGS means you’re spending more money on goods, which can lead to lower profits but higher satisfaction among customers.
- A low COGS means you’re spending less money on goods, which can lead to higher profits or can lead to customer returns if goods are not of high enough quality.
3. Sales tax
Sales tax is required to be collected in any state where your company maintains an ‘economic nexus.’ That’s a legislator’s way of saying a reason to pay tax. “A nexus could be created through the presence of an office, warehouse, remote employee or hitting a state-specific sales threshold, generally $100,000 or 200 transactions,” says Phil Gatto, co-founder of e-commerce business Suitably.
“Some states have county-level taxes as well as various exemptions for product categories such as apparel. All of this can be hugely complicated to navigate on your own.”
4. Inventory turnover
When we say inventory we mean stock aka our product, the good your entire business relies on to earn and grow. So this is a metric that matters a lot in the world of e-commerce and retail financial management.
“Inventory turnover is equal to the annual cost of goods sold divided by inventory,” says Gatto. “It’s an important measure of a company’s capital efficiency, showing how many times it sold through all of its inventory on hand.”
- A high inventory turnover means that a business will have less money tied up in inventory, which can free up cash for other purposes.
- A low inventory turnover, on the other hand, can tie up a business's cash in inventory that is not selling, which can lead to cash flow problems.
“Inventory turnover is an important measure of whether a company has an efficient supply chain, and demand forecasting process. The higher inventory turnover is, the less capital is tied up in maintaining excess inventory and can thereby be invested in growing the business as a whole,” says Gatto.
5. Average order value (AOV)
Your average order value can be calculated by taking total sales for a period of time, and dividing it by the number of orders in the same period. If your business is set up on Shopify, or a similar e-commerce platform, you can find this metric on your analytics page.
6. Cost per acquisition (CPA)
CPA is a critical marketing metric that determines the cost of customer acquisition for a specific campaign or channel. It is one of the most prominent metrics on the dashboards of online ad platforms like Facebook, Instagram, and Google, etc.
- A high CPA can eat into profits, so it's important to keep an eye on this metric.
- A low CPA, on the other hand, can indicate that your marketing efforts are effective and that you're efficiently acquiring new customers.
Understanding CPA will help you see whether your company can grow profitably.
7. Gross profit margin
Gross profit margin is an important financial ratio for e-commerce founders and finance managers. That’s because it shows how much profit is made after subtracting your COGS. You can use this information to make pricing, product, and marketing decisions. And, more importantly, you can use it to understand if your initial business model is working, or if it needs a reboot.
8. Accrued expenses
This is a list of expenses you've incurred but haven't yet paid for, or a list of sales you've made but haven’t yet billed. Accruals can be positive or negative, affecting the income statement as well as the balance sheet. Accrual accounts are used to identify funds that will be deposited into your accounts but haven't yet, usually due to the length of time it takes to complete the accounting process.
Why managing your e-commerce finances is a challenge
Managing finances for an e-commerce business is far from easy. In fact, 90% of e-commerce businesses fail within their first four months of operating because of a myriad of operational challenges.
Rising operating costs
For example, high operating costs related to inventory, freight, and marketing can leave e-commerce businesses without the cash on-hand needed to secure adequate lines of credit from traditional credit card companies.
Solution: Start using finance automation software like Ramp early to identify your most rapidly rising costs.
Limited credit access
Without support from the traditional world of financial services, e-commerce businesses can struggle to scale their operations. It can be challenging for emerging online retail businesses without a long operating history to get any kind of loan or line of credit. And traditional cash-based underwriting doesn’t support the needs of e-commerce businesses that put most of their money into working capital—the ongoing spending that keeps the business ticking over.
“Regardless of how profitable a business is, things end when you run out of cash, so monitoring where cash is going and why is crucially important,” — Paul Sundin, CPA and tax strategist at Estate CPA .
Ramp's commerce-based underwriting alleviates this issue, with connections to Shopify, Stripe, and others to unlock revenue-based underwriting. It’s a new way to give retailers access to the capital they need to grow and the tools they need to manage it effectively.
Solution: Explore sales-based underwriting, giving you access to up to 30x higher limits with corporate cards like Ramp that also give you cashback.
Unknown spending impact
Payments, expenses, and accounting are also typically fragmented across systems, making it difficult to see the impact of your dollars spent. That’s frustrating, especially in the early days when you’re trying to manage wildly different activities across branding, advertising, and technology—all to scale the reach of your business.
Solution: Integrate any HR, accounting and collaboration applications to financial automation software to quickly assess spending against usefulness.
Unpredictable sales volume
The high-volume and high-pace nature of online commerce requires more control and insight into inventory, shipping, and advertising costs and better integrations for cloud software that helps founders and their teams keep the show on the road.
Solution: Save money with 1.5% cashback, shipping perks, and SaaS procurement to help you get through periods of ‘lumpy’ sales numbers.
Poor cash flow visibility
Even when you do get your hands on some useful capital, it can be difficult to manage how you use those funds given the fragmentation problem we just touched on. And that can be an unnecessary source of financial worry and doubt, a problem e-commerce founders shouldn't have to deal with alone.
Solution: Make faster decisions with real-time reporting and control outflows of capital with precise controls for merchants and categories, like social media advertising.
Few industry contacts
Many e-commerce businesses don’t have relationships with key partners who could help them scale through savings on their monthly expenses. Unfortunately, unless you’re a large business with an established reputation, creating these partner relationships can be difficult to navigate, leaving you paying top dollar for all of your solutions for inventory, advertising, shipping and more.
Solution: Harness Ramp’s network of marketing agencies and technology integrators including UberFreight, 71lbs, and EasyPost so you can get advice about e-commerce brand strategy, software procurement, and implementation.
Key financial statements for e-commerce owners
Those are definitely some difficult challenges. But they’re not insurmountable. You can take some early steps to solving these problems by getting a deeper understanding of how cash ebbs and flows in your e-commerce business. Which means you’re going to need to get up to speed with some important financial statements.
1. The cash flow statement
This shows you all the cash ‘ins’ and ‘outs’ during a given period of time. For this reason, it is one of the most important statements for a growing e-commerce business, according to CPA Abir Syed. “Regardless of how profitable a business is, things end when you run out of cash, so monitoring where cash is going and why is crucially important,” he says.
“The cash flow statement is a rundown of all the business transactions made within a specific period of time and is made of three components: the amount of cash from your products or services, investing activities such as new equipment, and financing activities like business loans or raise capital.”
2. The chart of accounts
Technically, this is more of a list of statements than a standalone one in its own right. A chart of accounts is a list of all the accounts you use to track the financial transactions that go through a business. It is usually divided into five categories: assets, liabilities, equity, income, and expenses. Here is what they mean:
- Assets: This account type includes anything that has monetary value and can be used to generate income for your business. Examples of assets include cash, inventory, accounts receivable, and investments.
- Liabilities: This account type includes any funds your e-commerce business owes. Examples of liabilities include loans, credit cards, and accounts payable.
- Income: This account category includes all the revenue your online business brings in. Examples include sales of goods and services, interest income, and dividends.
- Expenses: Everything your business spends. Examples of expenses include rent, inventory, product photography, e-commerce platform subscriptions, payment gateway fees, shipping costs, marketing costs, and web hosting.
- Equity: This may not be that important for new e-commerce businesses. This account type covers any ownership interests of shareholders. Equity can be positive or negative, depending on whether your business is profitable or loss-making.
“Most businesses use the chart of accounts as a guide to making informed decisions about their future as well as to track assets, keep track of where the money is going, and efficiently fill out their tax forms,” says Sundin.
And according to Syed: “While there are a few accounts that will always be present, such as a cash account and a retained earnings account, most of the chart’s accounts are flexible.
A chart of accounts can be ‘very simple’, says Syed, with the fewest number of accounts, such as having one single account for advertising. “Or it can proliferate endlessly, such as having a separate account for Google Ads, Facebook Ads, and TikTok Ads,” he says.
“Inventory is held at cost, which means the actual value that is generated when the inventory is sold can be much higher.” — Abir Syed, CPA.
3. The income statement
This shows you all your revenues and expenses over a given time frame. These are usually prepared on an accrual basis meaning it's based on when revenues and expenses are incurred but not when cash is transacted.
“The biggest example of this for e-commerce businesses is when a large purchase of inventory is done," says Syed. “While there's a significant cash outflow, this doesn't affect the income statement. The income statement would only show the expense of inventory when it's sold.”
Importantly, e-commerce businesses can also use the income statement to measure their ability to make a profit, so they can attract future investors and lenders, says Sundin. “Income statement data can also help formulate decisions around production capacity, closing down or opening up new departments, and tapping into a new target audience in the market.”
4. The balance sheet
Your balance sheet shows you all your assets and liabilities at a point in time. “Typically, a positive asset balance equates to a healthy company while a negative one shows the company is insolvent,” says Sundin.
For a startup e-commerce business, your most important assets are your cash and your inventory. The most important liabilities in your early days are often your accounts payable—the amounts you owe vendors—and debt.
“Your cash balance is indicative of how much value your business has in cash, and your accounts payable are indicative of how much you owe. But the same isn't quite the case for inventory,” explains Syed. “Inventory is held at cost, which means the actual value that is generated when the inventory is sold can be much higher.”
How to make the right start with e-commerce accounting
If you’re feeling a little overwhelmed or daunted by the statements Syed and Sundin have just explained, then here’s a helpful reminder.
You only need to know enough about accounting and bookkeeping, you don’t need to be an expert yourself. A combination of the right bookkeeper and accountant, along with modern tools built for e-commerce finances, can take you the rest of the way.
- Engage a bookkeeper and accountant: Solid bookkeepers and accountants are worth their weight in gold. They can help you set up your must-have financial statements and bring some clarity to the chaos of startup e-commerce finances.
- Get great accounting software: Inexpensive cloud accounting software like Xero and QuickBooks can really help you keep track of finances, with quick access to all of the statements we mentioned earlier.
- Connect your e-commerce platforms: With Ramp, you can now share data from leading e-commerce platforms like Stripe, Amazon and Shopify to unlock higher card limits and much faster access to commerce sales-based working capital.
- Track every dollar you spend instantly: Track business expenses automatically. See where you’re spending the most instantly. Search and filter to analyze spend by department, location, merchant and more to find new ways to cut wasteful spending and save money.
- Record expenses and match receipts by phone: Submit receipts the moment you spend—by text or email. Ramp automatically collects, verifies, and reconciles over 90% of receipts to automate employee expense reports. This helps you stay on top of record-keeping requirements from state and federal bodies.
- Handle invoices and pay bills in seconds: Make invoice processing less of a chore. Pay inventory suppliers by card, check, or ACH. Use software like Ramp to save you days each month by automatically categorizing payments and syncing with accounting software like Quickbooks, Xero, and Sage.
- Automate accounting tasks: You can also use software like Ramp to forward invoices by email and automatically detect vendors, line items, and payment details. When you make these payments with a Ramp corporate card, you can also get 1.5% cashback on big expenses like Google Ads and website development.
More than 5000 businesses including e-commerce brands like Cometeer and Faire have started using Ramp to secure more working capital and save 3.5 million hours through cashback, reporting, and accounting automation that helps them close their books faster. Join them today.