Answers to all the most important questions about ecommerce accounting, from software and data integration to taxes and reporting
This post is by Mike Cortes, owner of ecommerce bookkeeping and financial coaching service Zynergy Books.
Accurate bookkeeping is the foundation for any ecommerce business. Proper accounting can take that foundation and build a successful future for you and all that you worked hard for.
Unfortunately, many entrepreneurs view ecommerce accounting and bookkeeping as burdensome and put it off until the end of the reporting period. What many fail to realize is that procrastination could be costing them tens of thousands of dollars annually, by not properly planning and strategizing with their bookkeeper and accountant.
The goal of this article is to empower you, the ecommerce professional, to take action on your finances and reap the rewards that you so greatly deserve.
- How can accounting help me pay less tax?
- What do I need in place to do ecommerce accounting properly?
- What’s the best ecommerce accounting software?
- Do I need to print all my electronic records onto paper?
- Which reports or financial statements should I be looking at? What can they tell me?
- What’s the difference between bookkeeping and accounting?
- What’s the difference between cash flow and profit?
- How do I connect my accounting software to my marketplaces and ecommerce platforms?
- What are the most common problems when it comes to ecommerce accounting?
- How do I account for sales tax?
How can accounting help me pay less tax?
Every successful business owner knows that how much you make is less important than how much you keep. As business owners, we are subject to potentially higher taxes and, to make matters worse, no one sits with you along the way and guides you on how to reduce your taxable income but maximize profit.
Ecommerce bookkeeping is knowing how to plug the numbers correctly into your management software. It is the very foundation for all things to come, as your accountant will then be able to read your financial statements and accurately assess your tax obligation.
But it doesn’t stop there, because knowing how to reduce taxes throughout the year is vital to helping your business succeed. For example, a rule of thumb is that most sole proprietors exceeding $40k in annual net income should convert to an S-Corporation. That way, business owners can take quarterly distributions in addition to their salary, reducing their taxable income significantly.
Here is an example: John owns an Amazon business where he generated $100k in profit last year in the United States. He thankfully prepaid his taxes throughout the year because his accountant advised him to, but then he left it at that. His total tax obligation? Likely over $40k.
By converting to an S-Corporation John could pay himself a salary of $50k and write quarterly distribution checks to himself for the remaining $50k, which is taxed typically at around 15%. His tax obligation would have been reduced to only $26k. That is a $14k savings from a simple adjustment!
You can even retroactively convert your business to an S-Corporation as the IRS does allow for this with only a few stipulations.
What do I need in place to do ecommerce accounting properly?
There are several systems that you will need in place:
- Cloud-based bookkeeping software
- Business tax ID number
- Business checking account
If you don’t implement these basic requirements you are going to face a very upset bookkeeper and accountant, and your next bill from them will reflect the extra hours they spent cleaning up your financials.
Reconcile your transactions at least every few weeks by scheduling a day and time in your calendar. Routine bookkeeping this way will save you hours every month, and even more hours annually, because it will prevent procrastination and relying on fuzzy memory.
Next, every month verify that your trial balance on the monthly statement date matches up exactly with your bookkeeping balance. If it doesn’t, go back and find if perhaps there was a duplicate transaction or if the auto-feed from your bank may have missed a transaction.
Pay your sales tax to the appropriate state or states where you have nexus, typically quarterly.
Lastly, review your balance sheet, income statement and cash flow statement at least quarterly to see how your business is performing financially.
Stop using your personal account and multiple credit and debit cards, as it makes it nearly impossible for anyone to decipher your financials. Unfortunately, we see this a lot with small businesses, and it’s the bookkeeper’s job to clean up the mess in order for the accountant to execute their job correctly.
What’s the best ecommerce accounting software?
The best software comes down to the one you will consistently use. I have met several people who insist on using simple spreadsheets, but that seldom works well unless you are an amateur eBay seller grossing less than $10k annually.
Also, keep in mind that most bookkeepers and accountants can provide discounts on monthly subscriptions to both software tools, so make sure to ask.
There are several additional low-cost apps that I recommend to anybody who is in business for themselves. Those include a scanner app to store all your receipts. Genius Scan is my personal favorite and there are countless others available. Most are a one-time cost of less than $10 and are priceless in my own business operations.
Almost daily I have a business expense where I easily pull out my scanner app and record the receipt. I then upload large transaction receipts and attach to the expense. For smaller everyday expenses such as getting coffee for a client, I attach the PDF file at the end of the year to my Xero account.
Additional software that can help make life easier is Hubdoc, which will scan and attach your expense receipts to expenses in your Xero or QBO ledger.
Do I need to print all my electronic records onto paper?
There is no requirement to keep paper records in the United States, but you are required to keep accurate records per IRS regulations. Receipts fade with time and so immediately scanning them with your smartphone app solves that issue. The IRS will accept digital copies of documents as long as they are identical to the original copies and you can provide them upon request.
We keep a digital file cabinet in the cloud with bank-level encryption so that we can pull the records at a moments notice if a client has a question. If you do the same your bookkeeper and accountant will thank you, as most business owners still hand over the proverbial shoebox of receipts and beg someone to solve their problem.
Handing over a disorganized system will cost you potentially thousands of dollars in back-work to organize your expense receipts.
Which reports or financial statements should I be looking at? What can they tell me?
There are three main reports that every business owner must have and understand how to interpret.
1. Balance sheet
Your balance sheet will show all of your total assets (the net worth of the company). These include things like current as well as non-current and intangible assets. It will also show your liabilities, meaning your financial obligations (debts, etc.). The bottom line will show the owner or shareholders’ equity. Balance sheets will always reflect a snapshot in time, such as the very last day of your reporting period.
The easiest way to think of a balance sheet is like when you take a photo on your smartphone. It’s an instant view of the company’s net worth.
Without a proper balance sheet, it will be very hard to request loans or a line of credit from a bank. It is one of the basic considerations along with your credit score when applying for financing.
2. Income statement (profit and loss)
You often hear of the income statement referred to as the profit and loss statement (P&L). Whereas the balance sheet is a snapshot in time, think of your income statement as a short movie clip. It can be viewed as either a monthly, quarterly or annual report of the business’s performance.
The income statement will show a summary of the total revenues and expenses that a company incurs during a specific period in time and will either show a profit (net income) or loss (net loss).
However, just because you are profitable does NOT mean you are actually seeing that money in the bank! Why is that? It is because of the next item that we will discuss.
3. Cash flow statement
The cash flow statement is a bit harder to conceptualize, but it is one of the most important to grasp. Your cash flow statement summarizes all of your cash inflows and outflows over a period of time (think again of the movie clip analogy). Because it takes into account solely cash activity, it does not account of sales or purchases with credit, or depreciation of assets.
The cash flow statement will always be broken down into three sections:
This shows the areas that are producing the most cash and which are consuming it the fastest. If you use your cash flow statement effectively with your bookkeeper and accountant, then you can have a better prediction of future cash flows in order to budget and make better decisions for your company.
The most important thing to understand is that your cash flow statement will not reflect your profit or net income, because it does not take into account items bought or sold on credit.
Need an example? Try visualizing what most wholesalers or manufacturers do when they sell a product to you (the purchaser) to resell online. If they extend credit to you it may take 30 or more days to receive full payment. However, the business making the sale must report the income today and then pay taxes on that imaginary income.
To make matters worse, it costs them money to manufacture the item and so their cash flow statement would show expenses for producing the product, and no money (yet) received. Therefore, the financials will appear different on the income statement versus the cash flow statement.
This applies to an ecommerce business, when they have to pay for labor and goods before they ever see a product sold. Also consider if you sell on Amazon or eBay and they hold your funds as a rolling reserve. Even if you sell items with high margins, the mismatch between money coming in and going out might cause you to struggle for a period.
What’s the difference between bookkeeping and accounting?
While both bookkeeping and accounting are crucial business functions they are uniquely different.
- Bookkeeping is the accurate recording of your business’s financial transactions.
- Accounting is the proper interpretation of those transactions.
To take it a step further, without proper bookkeeping there is no way for your accountant to interpret and analyze your financial data. Even worse, your accountant will have no way to counsel you on how to improve financially.
You can think of bookkeeping as providing your financial vocabulary, and accounting as using those words to tell your full financial story.
What’s the difference between cash flow and profit?
Cash flow is the amount of cash available at any given time whereas profit is simply your surplus after all expenses are deducted from your revenue.
Many people fall victim to this unfortunate error in business management. I once had a bookkeeper who simply reported the numbers to my accountant, and after a record-breaking year I decided to splurge and give myself a nice bonus. I later discovered through my accountant that I owed nearly $20k in taxes for the preceding year. How could that be if there was little cash in the bank?
You can have profit without cash flow
I then decided to become certified in bookkeeping and learned that what happened is quite common. I took out excessive cash to pay myself leaving the business with less operating money, only to discover that I had underpaid my federal taxes as well. It was the perfect storm.
The opposite can also be true – you can have cash flow without profit. This can occur when someone (yourself or an equity investor) contributes money to your business via personal savings or a loan. Many growth companies experience this and have to ultimately take on new investors to bolster their balance sheet. Unfortunately, it typically dilutes the value of each shareholder’s original stake.
How do I connect my accounting software to my marketplaces and ecommerce platforms?
There are a few free methods that will provide basic financial reporting, and there are third-party tools that will better itemize your revenue and expenses.
You can integrate eBay by syncing your PayPal account into either QBO or Xero. Whenever you make a transfer of funds from PayPal it will simply display as one lump sum under “revenue”. In other words, you won’t have data on which products are providing the highest revenue for your business or what the processing fees were. You will only have a general description (e.g. “Revenue” or “Sales”) and the source (e.g. “PayPal”).
With regards to Amazon selling, once you add your business checking account into Seller Central the deposits will appear in your bookkeeping software. Once again, only the aggregate sum of the deposit will display under “revenue” with no itemization.
If you want software that can itemize in finer detail for your financial reporting, there are several applications available.
Our personal favorite for Amazon is A2X Accounting, which is a great application to itemize your sales report. A2X generates journal entries from each settlement and posts them to your cloud accounting software. For eBay sellers, Webgility is a great tool to accomplish the same end result.
An important thing to note here is that bookkeepers will typically charge you for monthly transactions in excess of 75 per month. With both applications above, you could exceed those limits so ask your bookkeeper if they will lift them. A good bookkeeper will be able to create rules within your software for them to more efficiently annotate transactions, saving you the unnecessary excess fees.
The most important features to look for in a paid application is whether they itemize the sources of your revenue for financial reporting, for example batching transactions into “consumer electronics”, “health and beauty”, “apparel”, “final value fees” etc.
What are the most common problems when it comes to ecommerce accounting?
1. Leaving it to the last minute
The biggest problem is that businesses simply avoid getting their finances in order until it is too late in the tax year.
Too often, clients come to us panicking, because they used a personal checking account and their Social Security Number (SSN) instead of a business checking account and EIN from the IRS. This results in highly inaccurate bookkeeping and accounting.
2. Finding an accountant that understands ecommerce
Another issue is finding an accountant that understands how Amazon, eBay or other third party platforms operate, particularly in terms of fees.
My original accountant did not believe me that Amazon was collecting 22% total commission on my apparel sales, until I showed them the reports from Seller Central. We spent needless hours explaining the fees, only to have our accountant finally accept that they were accurate.
3. Refunds and chargebacks
With regards to reconciling transactions, the biggest hiccups we see with businesses doing their own books is how to record transactions like returns and chargebacks. This can be recorded as two new entries in your chart of accounts. For refunds, use “Sales – Returns and Allowances”. For chargebacks, you can use “Bad Debt Expense.”
4. Missing errors
Errors are another common issue, such as duplicates showing up in your ledger or perhaps your bank transactions not syncing with your bookkeeping system.
If an error is missed initially it is the job of a good bookkeeper or savvy business owner to reconcile their accounts against what is called a “trial balance”. In other words, your balance in your bookkeeping software should exactly match what is in your business checking for a specific date at the end of a reporting statement form your bank.
Do not panic if your software fails to sync or integrate. Your bank should allow you to download an .ofx file or other format which you then upload into your bookkeeping system. It is a lot easier than you might think and quickly resolves the problem.
5. Not benefiting financially
Staying on top of accounting in your ecommerce business should not be a chore, but a huge tax benefit and cost saving. How could that be?
A good bookkeeper and accountant will maintain an open dialogue with you, the client, and answers questions that you did not even realize you had. We’ve had clients go from hefty tax bills year after year, and just accepting it as the price of running a business, to handsome refunds. It’s also common for businesses to lose receipts and miss out on deductions, which can be solved with a receipt scanning app and automatic saving to the cloud.
You can turn bookkeeping from a time-consuming chore to something that happens with little effort, and puts money in the bank.
How do I account for sales tax?
Sales tax is not income, it is a liability for your business until you hand it over to the state as per their required payment schedule. In a perfect world, you would itemize the revenue from Amazon or eBay and separate sales into “Revenue” and “Taxes Payable” in your bookkeeping software. A2X, Webgility and other apps do a great job of separating taxes for sellers. However, it doesn’t end there.
Before collecting sales tax, you should apply for an ID wherever you have nexus (for FBA sellers it’s more complicated). Then, create a login at your state’s department of revenue and set reminders in your calendar to pay on time. For many sellers, their payment schedule is quarterly. An app like TaxJar will tell you the exact amounts, showing which states you need to pay and when.
Amazon allows sellers to plug in their tax ID for each state that requires sales tax. This would apply to all fulfillment centers (FCs) where your goods are stored. I personally advise most clients to ship to a main hub such as in California, Illinois, Tennessee or Texas. That way, they only have sales taxes to collect in their home state and the state where the FC is located.
It is important to note recent changes to sales tax and the introduction of economic nexus. Following the U.S. Supreme Court ruling last year in South Dakota vs. Wayfair, states no longer need to rely on physical presence to require businesses to collect sales tax.
Thankfully, South Dakota decided to only apply sales tax to sellers grossing $100k or more in their state. Most other states have followed suit with similar requirements. The thresholds are welcome, but it still leaves sellers at risk of under-reporting. California announced this week that they will retroactively collect taxes on Amazon sellers for the preceding eight years.
The safest bet is to use third-party apps like TaxJar to show what you owe to each state and remind you when to pay. Most states will require smaller sellers to pay only quarterly with a 30-day grace period, so it should be an easy routine to implement.
This post was by Mike Cortes, owner of ecommerce bookkeeping and financial coaching service Zynergy Books. Mike helps small business owners grow their business and wealth by understanding the numbers and metrics within their business.