e-Commerce Accounting: The Only Guide You’ll Ever Need
Table of contents
Here’s some not-so-new news. 50% of accountancy professionals are unhappy in their current roles. Likewise, accounting in an e-commerce business is something that people avoid like a plague.
That being said, e-commerce accounting is an essential activity not to be avoided by anyone. It helps you understand your online business’s cash flow, profitability and long-term sustainability.
So here’s a comprehensive guide on e-commerce accounting. Let’s see what you should know about accounting for e-commerce, and what you can do to make the process more efficient and less excruciating!
- What is e-commerce accounting?
- Why is accounting for e-commerce important?
- Accounting vs. bookkeeping: What’s the difference?
- e-Commerce accounting methods
- Things you need before doing accounting for your online business
- e-Commerce accounting best practices
- Some last words
What is e-commerce accounting?
e-Commerce accounting refers to the systematic analysis and reporting of financial data in an online business.
It provides a reliable system of records, offering visibility into your company’s data and forms the foundation of many business decisions.
Why is accounting for e-commerce important?
Accounting for e-commerce business isn’t only about putting all transaction information on paper. It does much more than that.
So why is e-commerce accounting important for an online business? Here are 3 reasons to answer the question.
1. e-Commerce accounting helps you understand your business’s financial performance.
Running an online store without knowing the numbers is like throwing darts blindfolded.
What’s the revenue and expense of your business in the past quarter? How much fixed costs do you incur in a month? Do your net profit margins make sense?
These are some crucial aspects closely tied to your business’s profitability and sustainability, and e-commerce accounting helps you keep track of them.
2. e-Commerce accounting informs business decisions.
Be they large or small, business decisions can be more wisely made when you have neat and adequate information to make forecasts on.
Let’s say you run an online shop that sells reference books and materials to college students. You’ve looked into the accounting records and found that semester breaks are the slow months for your business.
Knowing this information, you’ll be able to make future projections and formulate corresponding strategies to optimize business performance, such as by reducing inventory levels and giving promotional offers during the historically poor-performing months.
3. e-Commerce accounting ensures tax compliance.
In most tax regions, businesses are legally required to retain proper records of all transactions for a certain period.
Having proper accounting procedures in place, therefore, is important not only for internal uses of financial information, but for legal compliance as well.
Accounting vs. bookkeeping: What’s the difference?
Accounting and bookkeeping are two relevant concepts, but they’re not synonymous.
For starters, bookkeeping is the practice of recording and tracking your business’s finances. In its simplest form, bookkeeping involves the recording of business transactions and documents on a day-to-day basis.
Accounting, on the other hand, is the practice of analyzing financial records produced by the bookkeeper. Financial reports, models and forecasts are then created, giving you insights into your business’s financial performance to inform future plans and strategies.
To illustrate the differences between these two activities, below are some examples of tasks involved in e-commerce accounting and bookkeeping.
Key bookkeeping tasks:
- Categorization of transactions
- Account reconciliation
- Preparation of balance sheets
- Payroll management
- Account payables and receivables management
Key accounting tasks:
- Preparation of adjusted entries
- Auditing of financial information
- Tax planning and reporting
- Financial forecasting and risk analysis
- Preparation of financial statements
e-Commerce accounting methods
While accounting standards and practices may vary across geographies, there are two types of accounting systems widely adopted across the globe. These two methods are known as cash basis accounting and accrual accounting.
1. Cash basis accounting
In cash basis accounting, revenues and expenses are recognized at the time when cash is received or paid. This accounting method is rather straightforward as it mirrors the actual movement of money into and out of your business.
Cash basis accounting example
Advantages of cash basis accounting
- Simple to use
- Tax liability may be deferred by controlling the timing of money inflow
- Gives a clear view of the amount of cash possessed by your business
Disadvantages of cash basis accounting
- Doesn’t show the whole picture of your business’s financial position (e.g. liabilities)
- Susceptible to business data manipulation
- Financial statements prepared under the cash method can’t be audited
Who can use cash basis accounting?
Cash basis accounting can be used by sole proprietors and small businesses.
However, this accounting method isn’t desirable for larger companies or businesses that sell on credit because it doesn’t recognize accounts receivables and payables.
2. Accrual accounting
Accrual basis accounting requires a business to record its revenues and expenses when they are earned or incurred respectively. This is so even if the money is not yet received or paid.
Accrual accounting example
Advantages of accrual accounting
- Provides a holistic view of your business’s finances (not only cash)
- Compliant with major accounting standards and principles
- Prevents management manipulation of cash flow
Disadvantages of accrual accounting
- Requires additional bookkeeping (e.g. accounts receivables and payables)
- You may need to pay taxes on a transaction before the customer pays you
Who should use accrual accounting?
Accrual accounting should be used by larger businesses, especially those that have lenders, auditors or investors involved.
In fact, the use of accrual accounting method is mandated by both the International Financial Reporting Standards (IFRS), and the generally accepted accounting principles (GAAP) in the United States.
Things you need before doing accounting for your online business
Difficult terminology and complex procedures are often overwhelming to those who are new to e-commerce accounting. To simplify things for you and get you started on accounting for e-commerce, below are three items that you should prepare.
1. Business bank account
The very first rule of business accounting is to not mix your personal finances with that of your business. Therefore, it’s crucial that you set up a business bank account dedicated for your e-commerce store, as well as other business accounts for online payment wallets.
2. Business tax identification number
A business tax ID number is a unique sequence of numbers or letters that identifies your business for tax purposes.
For instance, every business entity subject to tax in Singapore is assigned a 9 to 10-digit combination of numbers and letters, known as the Unique Entity Number (UEN), whereas in Hong Kong, the Business Registration Number (BRN) serves as the tax ID.
3. Accounting software
The last item on the list isn’t an essential, but rather a good-to-have for e-commerce accounting.
Simply put, accounting software stores your business’s financial data in one place, and automates various bookkeeping and accounting tasks for your business. These include invoicing, bill payment, payroll management and financial reporting, and the list goes on.
Although these software represent an extra expense item on the books, they are used by many businesses for the benefit of time and cost savings brought about by e-commerce automation.
Accounting software examples:
- Sage Business Cloud Accounting
e-Commerce accounting best practices
Moving on to the actual process of accounting for e-commerce, here are some best practices that you can follow.
Done well, you’d be able to reduce the time and manpower spent on this monotonous activity, and save yourself from the painful loop of being stuck in numbers and paperwork.
1. Maintain accurate financial records
Accurate record keeping is essential to support any claims or information that you submit to the authorities. As mentioned earlier, proper retention of records is also a legal requirement for businesses in most places.
As a best practice, below is a list of items that you should keep a record of:
- Invoices, bills and receipts
- Bank account and card statements
- Account statements from online payment wallets
- Revenue records from your e-commerce store or platform
- Canceled and bounced checks
- Employer’s returns of remuneration
- Past tax returns
2. Categorize all business transactions
Categorization of transactions is one of the very first steps in the bookkeeping process, which is pivotal to e-commerce accounting. Make sure every transaction is classified as either an income or expense, and it’d be best to further group them under different categories.
For digital merchants, common expense categories include:
- Advertising and marketing
- Cost of goods sold (COGS)
- Website and software
- General and administrative expenses
- Postage and shipping
If transaction categorization sounds like a lot of trouble, consider using accounting software to help you out.
Many of these software have pre-built filters and sorting functions, and can auto-sort expenses into their respective categories.
Instead of performing this essential yet repetitive activity using salaried employees' hours, their valuable time can be allocated to higher priority objectives, such as growing your online business.
3. Keep track of your cost of goods sold
Cost of goods sold, sometimes abbreviated as COGS, refers to the cost incurred in relation to the sale of goods. Fees that contribute towards your COGS include the costs of raw materials, shipping and purchases, but to name a few.
Managing your COGS is important for the financial health of your online business in the long run. It lets you know how much gross profit you can earn from each sale, as well as the budget you can stretch without harming your net profit.
4. Distinguish between refunds and chargebacks
Evidently, refunds and chargebacks are common issues faced by digital merchants, but how should you record for these events in the books? Here’s how you can do it.
Accounting for e-commerce refunds
Refunds occur when customers are dissatisfied with your products and request return of their money (and the goods). It’s usually governed by your online store’s return and refund policy, and can be handled in different ways.
To begin, full refund can be made to customers once they’ve returned the goods to you. The canceled transaction can be categorized under the “returns and allowances” category, with the order value subtracted from your sales revenue.
On the other hand, some digital merchants prefer to substitute store credits for a cash refund, so no cash changes hands in the process of a return and refund. Once deposited in a user’s account, the store credits can be used to purchase other items from your e-commerce site.
In this type of refund, the disputed transaction should be recorded as an expense. An item should then be added to accounts payable to reflect the store credits given to the customer.
Accounting for chargebacks
Chargeback, sometimes known as reversal, is the return of credit card funds by a merchant to a customer.
One scenario leading to a chargeback is e-commerce fraud, such as when a buyer disputes a purchase on the grounds that the credit card transaction was made without his knowledge or permission.
When chargebacks are processed, they should be categorized as “returns and allowances”. Any extra fees involved in a chargeback should be marked as a business expense.
5. Integrate accounting software with your online store
Manually logging sales data in an accounting system is both time-consuming and inefficient, especially when your online shop has a sizable transaction volume.
That’s why many e-commerce platforms now offer integration options, enabling you to connect your online shop with third-party software, such as accounting and data analytics tools (speaking of data analytics solutions, we have one at Choco Up!)
For instance, Shopify merchants can use the QuickBooks Connector to sync their sales data with QuickBooks Online, a cloud accounting software. Not only does it help save time on manual data entry, but it also minimizes errors and maximizes accounting accuracy.
6. Reconcile accounts on a regular basis
As you may already know, online transaction errors aren’t too frequent, but they aren’t uncommon either. For instance, you may be charged twice by the bank when making payment to a supplier, or your customers’ payments don’t go through successfully.
In order to identify and rectify these problems in a timely manner, it’s advisable to match your bank and accounting records on a regular basis. Monthly reconciliation is a common practice and can be applied at your online business.
7. Prepare early for the tax season
A lot of small business owners — especially those in their first year of business — are caught off guard when the annual tax return arrives at their mailbox.
However, preparation, collation and review of financial documents at the last minute is often painstakingly exhausting and prone to errors. That’s why you’re recommended to start preparing for taxes early.
Start by organizing financial documents and maintaining neat accounting records throughout the year. These will only take a few extra hours every week or month, but they’ll save you heaps of time by year end.
Some last words
e-Commerce accounting throws light on the finances of your online business. From the costs of goods sold to the net profit margins, you’ll find useful information and draw insights from the numbers on the books.
Looking at those figures, however, have you ever wondered how you can grow and scale your business to new heights? Do you want to scale up your marketing campaigns, launch a new product line, or expand into a new market?
If your answer to any of these questions is “yes”, then Choco Up can lend you a helping hand.
As a global technology and financial services platform, we not only offer revenue-based financing — a type of flexible, zero-equity funding — for digital merchants. We also provide a wide array of how-to articles and business growth solutions for our clients.
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