Setting up your ecommerce business can be an exciting time. You’ll have the opportunity to sell your products around the world, at any time of day or night, without having to invest in a brick and mortar store and a bunch of employees. You’re probably up to your ears with tasks such as choosing your store name, setting up your website, and categorizing your merchandise.
While these tasks are very important, it’s equally vital to take some time to think about your accounting system. While accounting can seem simple at first, if your store takes off, you need to have a strong system in place to avoid becoming overwhelmed. Here are some small business bookkeeping and accounting tips to keep your business running smoothly.
Know the Terminology
If you’ve never handled business accounting before, you might feel overwhelmed. Fortunately, the basics of ecommerce accounting are relatively simple. Here are the terms you need to know and what each means for your business.
- Bookkeeping vs. Accounting: Bookkeeping is the process of recording financial data, while accounting is the process of interpreting and analyzing it. In a small business, these terms are largely interchangeable.
- Inventory Management: Inventory is the merchandise you have available to sell. Inventory management is the system you use to keep track of your inventory, from the time you buy it from a supplier to the time it is delivered to a customer.
- Orders, Invoices, and Receipts: This is your paper trail that documents each step of the sales process. Orders may refer to the orders you place with suppliers or the orders customers place with you. Invoices are bills for money due. Receipts are proof of payment.
- Balance Sheet: The accounting equation states that Assets = Liabilities + Owners Equity. Your balance sheet shows your assets in one column and your liabilities in another. Assets include all the things the business owns, such as cash, inventory, outstanding invoices, and investments. Liabilities include everything the business owes, such as credit card debt, startup loans, and mortgage payments for your place of business.
- Cash Flow Statement: As the name implies, cash flow is the amount of money that goes into and out of your business. A cash flow statement accounts for that money. It lists every dollar that comes in, such as from sales, and every dollar that goes out, such as for inventory.
- Income Statement: An income statement focuses solely on the money that comes into the business. Operating income is money made directly from regular business activities such as sales, while non-operating income is money that comes from other sources, such as dividends from investments the company holds.
eCommerce Tax Considerations
In addition to your standard business or self-employment taxes, you may also be responsible for collecting sales tax on your orders and paying it to the relevant governmental agency. When to collect sales tax can be highly confusing. In general, you must collect sales tax when your business has a “sales tax nexus” in the relevant state.
At one time, this simply meant a physical location such as a home office or brick and mortar store. Today, though, many states claim sales tax nexus if you have inventory stored in that state (such as at a fulfillment center) or a drop shipping relationship with a company in that state. Check with an accountant or tax attorney for more details.
The good news is that you can claim quite a few income tax deductions for your ecommerce business. These include packaging and materials, home office expenses, marketing costs, business software, and the services of an accountant or other professional, among others. Ask your accountant for specific deductions that apply to your business.
What Are the Different Methods of Accounting?
Accounting for ecommerce companies, like all businesses, is typically done using one of two basic methods: the cash basis method or the accrual method. Large businesses are required to use the accrual method once they hit certain criteria, but the majority of small businesses are free to use either method.
- Cash Basis Method: The cash basis method is the most familiar, because it’s how most people balance their personal budgets. You record income when it comes in, and expenses when you pay them. For example, if you finish a project and bill the customer in May, but he doesn’t pay until July, you record the income in July. If your rent is due June 1st, but you don’t pay it until July 1st, you record the expense in July. This ensures that your records match your cash flow sheet, and it prevents you from having to pay taxes on money that you don’t yet have.
- Accrual Method: With the accrual method, you record income when it is earned, even if you haven’t yet been paid, and expenses when they’re incurred, even if you haven’t made payment yet. For example, if you finish a project and bill the customer in May, you record the income for May, even if the customer doesn’t pay you until July. If your rent is due June 1st, you record it on that date, even if you actually pay it on July 1st. This method makes it easier to see the health of your business and make accurate forecasts, but it could result in you paying taxes on anticipated rather than actual funds.
Both methods have pros and cons, and you must choose one method and stick with it—unless your business grows to the point that you are required to use the accrual method. Therefore, it’s best to get advice from a tax attorney or an accountant before making your decision.
eCommerce Accounting Software, Tools, and Services
Fortunately, you don’t need to do everything by hand or on your own. There are quite a few tools for ecommerce bookkeeping and accounting that can simplify the process for you.
Using ecommerce accounting software is an excellent solution. The biggest player in this space is QuickBooks, which commands most of the market and is well-integrated with numerous ecommerce apps and programs. Other popular options include Xero, Sage, and GoDaddy Bookkeeping.
Some bookkeeping and accounting software solutions also provide inventory management systems, or you can choose a separate system. Either way, choose tools that will help you automate your daily processes. Using a sales tax software system can help you comply with the varying state regulations and ensure that you properly collect and pay sales tax in each location.
At income tax time, make sure you’re using a tax software solution that is designed for small business. TurboTax, H & R Block, and TaxAct are among the most popular.
Of course, it’s always best to seek financial advice from a qualified professional. Although you can do most of your bookkeeping, accounting, and tax filing yourself, consider checking in with a tax attorney or accountant at least once a year. These professionals can help ensure that you are doing everything correctly and make suggestions to improve your company’s financial health.
Tips to Ensure Smooth Financial Operations
Running an ecommerce business can be an excellent choice, but it can also bring financial headaches. Follow these simple tips to keep your finances running smoothly:
- Make a plan: Sit down on your own or with a financial professional and set some financial goals for your business. Figure out how much money you need to get started and whether you will need to raise funds. Choose the accounting method that works for your company, and set up your software solutions.
- Check your expenses before making purchases: In an ecommerce business, it’s incredibly tempting to drop a lot of money up front on inventory. Yet uncontrolled spending can sink your business before it gets started. Make a budget of the expenses you must pay, such as licenses, permits, and rent, and take that money out before you start buying inventory or nonessential items.
- Look for cheaper alternatives: You don’t want to skimp on your business, but you can always upgrade as you go along. Consider used office furniture, a low cost basic inventory management system, or a computer without all the bells and whistles.
- Avoid unexpected expenses: Do everything you can to minimize losses, such as only dealing with trusted suppliers and drop shipping companies. Follow all safety procedures and best practices. But be aware that things can happen at any time. Reliable business insurance is the key to protecting your company. At Next Insurance, we offer ecommerce insurance that is tailored to the unique needs of this type of business.
Final Thoughts
Accounting and bookkeeping are crucial to the success of your business. Fortunately, there are a variety of tools and services to help keep your books running smoothly. Setting up a strong system at the outset, checking in with your financial professional once a year, and protecting your company from unexpected expenses can help you avoid any unwelcome accounting surprises.
