In Pursuit of Profit
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Online businesses must manage chargebacks, sales tax complexities, varied fixed costs, and constrained cash flow operationally and as in relation to their books. Misclassifying or mishandling these unique variables can have serious financial consequences, making them a top priority for business owners.
While chargebacks are less common in traditional retail businesses, e-commerce businesses must deal with the accounting complexities that result from transactions that are charged back due to fraudulent online activity. According to recent retail data, global e-commerce chargebacks topped $40 billion in 2018. Chargeback fees must be correctly categorized in the books as Returns and Allowances to understand profit margins better and make strategic decisions about fraud prevention. Incorrect handling of chargeback losses can skew financial reporting data unfavorably, thwarting a company’s attempts to forecast effectively.
Sales tax is one of the trickiest components of running an e-commerce business. Unlike a traditional retail store that only needs to worry about its own state’s sales tax, online stores must stay on top of collecting and reporting sales tax across state lines.
Most e-commerce platforms use a regularly updated tax table to determine how much tax to charge based on the purchaser’s location. Setting up products as taxable or tax-exempt tells the system when to charge sales tax, and then the system does the heavy lifting of computing taxes across applicable states, counties, and cities. That tax is collected on behalf of the business at checkout. Then the business is responsible for remitting it to the state’s tax authority each month, quarter, or year (depending on business type and location). Sales tax should not be recognized as revenue on the books. Instead, it should be recorded as a liability. Because once it has been collected, it is owed to the government and will subsequently be paid on a predetermined schedule.
With sales taxes constantly changing, this can get complicated quickly, which is why many e-commerce business owners use a professional accountant to manage this for them. Sales tax tools like TaxJar, Taxify, and Avalara can help as well for business owners that prefer a more hands-on approach.
Less experienced business owners may overlook or confuse expenses that should be recorded as COGS (Cost of Goods Sold). Items like shipping costs contribute to COGS because they are required to get products to customers and increase or decrease proportionally to the amount of product sold. Whether an e-commerce company chooses to offer variable shipping, flat rate shipping, or free shipping, there is an incurred cost that must be accounted for accurately. Businesses that offer free shipping do not eat the cost of shipping – they simply price it into their product costs.
When flat rate or free shipping is used, there can be discrepancies between what is collected and what is charged for shipping, resulting in either income or an expense. Creating a COGS Shipping Expense account helps to keep the income and costs associated with shipping separate from other income accounts and expense accounts. For businesses that want more granular information, you can create both a COGS Shipping Expense account and a COGS Shipping Income account to track money coming in and going out related to shipping products separately.
Calculating the break-even point is crucial for online companies and brick-and-mortar businesses alike. Sales need to cover fixed costs for a company to break even. Determining where its break-even point occurs is critical for informing budgeting and planning activities.
While this is a relatively basic concept, it tends to get overlooked by a lot of e-commerce store owners because they assume that they do not have high fixed costs since they typically do not have a lease or property to worry about. However, every business has some fixed costs, and e-commerce companies are no exception. While fixed costs may be lower or may not fall into the same buckets as a traditional retailer, they are still there. Knowing the total of these fixed costs is instrumental in arriving at an accurate break-even value.
All businesses rely on key financial statements to get an accurate picture of their health. E-commerce businesses should maintain the same financial reports that are important for all small businesses. Balance sheets, cash flow statements, and income statements are essential financial statements for businesses of all sizes across all industries and platforms. However, e-commerce businesses will typically find that their inventory and cash are their greatest assets rather than buildings and equipment like brick-and-mortar retailers. While cash flow is the lifeblood of any retail business, it is even more important for e-commerce stores because reduced barriers to entry often result in e-commerce businesses starting with less capital on hand. E-commerce businesses should ruthlessly prioritize cash flow when making operational and strategic decisions.
For more information related specifically to ecommerce finances, visit: Bookkeeping Essentials for Starting an Ecommerce Business.