Accounting is critical for every ecommerce business. Online retailers must rigorously monitor their finances because every dollar counts. A simple mistake could cause your company to lose significant money.
This article will explain what you need to know about ecommerce accounting and why it’s a vital consideration.
What Is Ecommerce Accounting?
It is the practice of accurately recording, classifying and managing all financial transactions relevant to an online retail operation. It is a subset of accounting designed to meet the needs of ecommerce businesses.
This practice ensures that your online retail business always has cash on hand to pay vendors and deliver goods to customers. It ensures you pay tax liabilities to avoid legal troubles and make reasonable financial decisions.
What Are the Types?
The two main methods of online retail accounting are cash basis and accrual.
This method involves recognizing revenues and expenses only when cash has exchanged hands. You’ll recognize revenue when money flows into your business and expenses when money flows out.
This method works very well for small businesses with simple finances. This way, the owner can always monitor the cash they have at their disposal.
This method involves recognizing revenues and expenses as soon as an agreement is formalized. You’ll record revenue as soon as you generate an invoice, regardless of when the customer actually pays the invoice. Similarly, you’ll recognize an expense as soon as you receive an invoice, regardless of when you actually pay it.
The accrual method is ideal for large online retailers because it becomes easier to make accurate financial projections. It considers accounts receivable and accounts payable, which every large retailer must keep track of.
The rule of thumb is that cash basis accounting is suitable for businesses with annual turnover of less than $1 million, and the accrual method is ideal for businesses with more than $1 million annual turnover.
Ecommerce Accounting Terms
The most important terms an ecommerce accountant should note include
A purchase order is a legally binding contract you issue to a customer requesting your items. It includes relevant details like the item’s name, quantity, and price. It should also include your payment details.
Generating a purchase order means you’re obliged to supply the required products to the customer. After creating this order, you can recognize the revenue immediately (accrual) or wait till you receive the payment (cash basis).
A sales order is the inverse of a purchase order. It’s the document a vendor issues to you when you request items from them. It includes all relevant information about the purchase, such as the quantity, price, and expected payment date. You can recognize an expense immediately after receiving the sales order (accrual) or wait till you pay for it (cash basis).
Accounts payable and accounts receivable
Accounts payable is the amount you owe to vendors and suppliers, reflecting your balance sheet.
Accounts receivable is the amount customers owe you, which also reflects on your balance sheet.
Most countries charge a sales tax on all local transactions. When a customer buys an item from your store, you should note their jurisdiction’s sales tax and ensure you pay it to the relevant tax authority. The good news is that you can automate this process with tax software.
Cash flow is the movement of money into and outside your business. Ensure you always have enough money to pay short-term bills, or your business risks collapsing.
What Does Ecommerce Accounting Entail?
It comprises three main aspects:
- Recording and classifying every financial transaction accurately.
- Tracking and remitting all applicable taxes, including sales, payroll, corporate income, etc.
- Forecasting revenue and profit growth based on your current circumstances.
We have explained ecommerce accounting, its types, important terms, and what it entails. Every online retailer needs the knowledge we’ve provided for free in this article.