Opening an e-commerce store is an exciting venture for any entrepreneur. With an online shop, your products are available day and night, year-round, to an international array of customers. The World Wide Web enables you to cast a wide net for a niche audience, drop-ship orders, and do it all while maintaining a small physical footprint.
Purchasing a domain name and hosting, setting up the website and store itself are all very important steps to take, but without sound financial planning, your store won’t gain much traction.
Once your new store has been set up and goes live on the internet, you will need to ensure that your stock levels are sufficient and that expenses are tracked, among other concerns. Quickbooks offers integratabtle solutions to help with all of these things.
What is Bookkeeping?
Basically, bookkeeping is the process of tracking the money that goes in and out of your business. When it comes to bookkeeping and accounting, the operation of an e-commerce business is not much different from running a conventional retail shop. Accounting for an online retail business translates to focusing on your inventory and cash flow, while using retail accounting software to help you pick up the slack.
As a retailer, your inventory is the bedrock of your business and almost everything you do is dependent upon it. Because of this, many of your financial documents and reports focus solely on your inventory.
What Makes Retail Bookkeeping Unique?
At a glance, the process of e-commerce bookkeeping and accounting is very similar to the way it’s done in other industries. If you understand the basics of bookkeeping, or have accounting experience from a previous career, you’re well on your way to understanding this subject. Even if your background is lacking in such experience, the principles of retail bookkeeping are fairly simple.
The Basics of E-commerce Bookkeeping
There are several necessary steps you must take when you’re setting up a bookkeeping workflow for an e-commerce store. A simplified version of this process might look something like this:
- Determine how you want to track and cost your inventory
- Download retail accounting software
- Create templates for sales orders, invoices, and receipts
- Start tracking your inventory
- Create a balance sheet, income statement, and cash flow statement for your first month of business
Before you start doing the math to figure out your revenue and costs, it’s a good idea to make sure you understand the basics. The best place to start is with financial statements.
Financial Statements You Need to Know About
As a business owner, you will need to maintain an up-to-date view of your finances at all times. When you have a clear picture what your money is doing, you can get a better handle on your business spending. This allows you to develop and consistently improve your profit margin. Financial statements offer an organized view of this information.
There are three main types of financial statements that are used in almost every business model, regardless of size or industry:
- Balance sheet
- Income statement
- Cash flow statement
The balance sheet is is a records of your assets, liabilities and owner equity. Assets equal the liabilities plus the owners equity (otherwise known as the Accounting equation: Assets = Liabilities + OE) A balance sheet usually consists of two columns; one defines your assets and the other defines your liabilities.
A balance sheet is so named because both columns should be balanced and show the same total profit or loss at the time you create the sheet. A balance sheet serves to illustrate the overall financial health of your business.
In one column of the balance sheet, you list all of your company’s assets. These include your inventory, cash funds, and accounts receivable or AR (money that clients owe your business and you expect to receive within a year). Because e-commerce retail tends to involve less physical space and equipment, your greatest assets are likely to be your cash and inventory. Investments and outstanding invoices should also go on your balance sheet.
In the other column, you must list your liabilities, which include such things as debts and money you owe for business-related reasons. A liability can range from an outstanding balance on a small business loan and credit card debt from business-related purchases to outstanding mortgage payments on your place of business or in the case of delivery trucks, vehicle payments for your fleet.
Your income statement includes all of the money brought in over a given time period, typically a month, quarter, or year. This statement shows both operating and non-operating income. Operating income is any money made through regular business activities; if you own an e-commerce clothing retail business, your primary operating income is from inventory sales.
Non-operating income reflects money made through means not directly linked to your business activities. To use the above example of a clothing retail store, your non-operating income might include property sales, equipment sales, or investment returns.
If you initially operated out of a warehouse, then sold that space and moved into a smaller one, profit from the sale would be considered non-operating income. The same would be true if you made a profit from reselling equipment like a sewing machine or if your company received dividends from an investment of its funds.
Cash Flow Statement
A cash flow statement is probably the most important document you can have as an e-commerce entrepreneur. It reveals every cost, such as rent, maintenance, and inventory, as well as every income stream, including every sale your company made during a given period of time.
A cash flow statement not only shows your company’s gross revenue (how much money was made from sales) and your net profit (how much money your company had left after expenses), but it reflects whether money spent is going toward business growth or being drained by unnecessary costs.
Cloud accounting software such as QuickBooks Online helps you to keep track of all these figures, because it makes the data you need for cash flow statements readily available. This is important because aside from being your most detailed financial report, an accurate cash flow statement can prevent overspending or running out of inventory.
Why Inventory Cash Flow Is Crucial for Retailers
Maintaining an organized, cost-effective inventory is perhaps the most important aspect of any retail e-commerce business model. Maintaining inventory is more than just stockpiling items you intend to sell; it also means keeping track of your inventory cash flow.
Cash flow refers to the amount of money “flowing” in and out of a business on a monthly, quarterly, or annual basis. When you know exactly how much money is passing through your business, it enables you to maintain a positive profit margin. If you suffer a loss, your cash flow statement pinpoints where overspending occurred so you can strategize to reverse the trend.
Calculating cash flow specifically for your inventory is essential. In an inventory cash flow document for example, costs listed should be exclusively inventory-related. This includes the price of purchasing your inventory of course, but you may also have to factor in additional items such as manufacturing and maintenance costs.
If you produce all the clothing you sell in-house, you might add the cost of raw materials and equipment acquisition/maintenance. If you have bulk inventory that has to stay frozen, you’d include the cost of running and maintaining your freezer in the cash flow sheet.
In addition to purchase and maintenance costs, you must track your actual sales as well as any inventory losses. Losses can result from theft, spoilage, damage, or other factors that make a piece of inventory unsellable. While of course you want to prevent inventory loss as much as possible, you should nevertheless be prepared to deal with it if and when it does occur.
Keeping track of inventory cash flow means knowing the overall cost and value of your inventory, which tells you how much net profit you make from the sale of your inventory.
To estimate the value of your inventory, you need to know how many units you’ve purchased, the cost of manufacturing or purchasing each unit, and how much you plan on marking up each unit when you sell it.
Inventory Costing Methods
There are a few different methods for working out the cost of your inventory. None of these methods is necessarily the best one, but certain methods might work better for you, depending on the type of items you’re selling. The most common methods of inventory costing are:
- First in first out (FIFO)
- Last in first out (LIFO)
- Weighted average
- The retail method
With the FIFO method, you assume that the first items you purchased for your inventory are also the first ones that you sell. This works well if your inventory is perishable (like food products or health supplements). Imagine you’re working out your inventory for the first quarter of the year, and you purchased three batches of inventory: one in January, one in February, and one in March.
- The January batch of inventory totaled 2,000 items, each costing $4
- The February batch totaled 2,000 items, each costing $6
- The March batch totaled 2,000 items, each costing $8
Over this quarter, you sold 5,000 units of inventory, meaning there was a total of 1,000 unsold. Since your March batch was the last “in,” you can assume the 1,000 unsold units this quarter are from the March batch, as everything in the earlier batches was sold first. To get the total cost of your inventory, simply add up the costs of all the items sold in order.
- (2,000 x $4) + (2,000 x $6) + (1,000 x $8) = $28,000
- $28,000 = your total inventory cost for the first quarter
The LIFO method is very similar, but with this method you assume that the most recently purchased items are the first to be sold. The LIFO method works well for retailers that are selling nonperishables such as clothing, books, jewelry or furniture.
As an example, assume you made the same quarterly purchases as the example above. Since you’re using the LIFO method this time, the 1,000 unsold units come out of your January batch. Now the calculation looks like this:
- (1,000 x $4) + (2,000 x $6) + (2,000 x $8) = $32,000
- $32,000 = your total inventory cost for the first quarter
The LIFO method is not permitted under IFRS or CRA.
Weighted average involves takes the average cost of all your inventory units and does not account for what inventory sold first. You simply calculate the total cost of everything you have on hand. Using the above example again, you’d first calculate the total value of the entire inventory:
- 2,000 x $4 = $8,000
- 2,000 x $6 = $12,000
- 2,000 x $8 = $16,000
Then add the total costs together to get one sum, and divide that sum by the total number of units in your inventory.
- ($8,000 + $12,000 + $16,000) / (2,000 x 3) = $6
- The average cost of all your inventory items is $6
If $6 is your weighted average, you can then multiply $6 by the number of units you actually sold. So if you sold 5,000 out of a total of 6,000 units, your total inventory cost is:
- 5,000 x $6 = $30,000
The Retail Method
With the retail method, you first need to determine your cost-to-retail ratio, which expresses your markup percentage. In the example above, imagine the items you purchased for $4 per unit are sold to your customers for $6.40 per unit. Your cost-to-retail ratio is 0.6, or 60%.
Now, determine how much money you made from sales this quarter. You sold 5,000 units, which cost your business $30,000 (according to the weighted average method). At a 60% markup, you brought in $48,000 in revenue. Divide your total revenue by your markup percentage, and subtract the new sum from your calculated cost.
- $48,000 / 0.6 = $28,800
- Total inventory cost = $30,000
- $30,000 – $28,800 = $1,200
- Your closing inventory cost is $1,200
While the method you use is up to you, they all exist to ensure that the final cost figure is correct by tracking your inventory accurately. This is where inventory tracking methods come in.
Inventory Tracking Methods
Determining the cost of your inventory doesn’t need to be complicated, but it does require a consistent and accurate picture of how many units of inventory you have at any given time. Keeping track of your physical inventory holdings is called inventory tracking, and there are two primary methods: periodic and perpetual.
Periodic Inventory Tracking
Using periodic inventory tracking, you must perform physical counts of your inventory at regularly scheduled intervals. A physical count involves counting every individual unit you have in stock and making a record of the cost and sale value of each item. Each time you recount, you can update your inventory cash flow sheet to reflect how much money your company spent and gained on inventory in that period.
Depending upon the size and complexity of your e-commerce business, you might choose to do periodic inventory annually, quarterly, or monthly. If your business is just starting out, you might benefit from doing it monthly, because this will help you get a more accurate picture of your overall inventory during a period of time when there’s likely to be more fluctuation as your business gets off the ground.
Perpetual Inventory Tracking
In this system, you’re always tracking your inventory, usually facilitated by the use of automated accounting software. Whenever an item is scanned for packaging or enters your inventory storage, the software automatically updates your inventory count, purchase account, and overall cash flow figures to perpetually represent the current value of your inventory.
QuickBooks Online Accountant offers inventory tracking services to automate your inventory and take advantage of the perpetual method. With this method, your total sales and inventory cost are instantly updated every time you add a new product to your inventory or sell an item. You can also integrate your QuickBooks account with your favourite store inventory app to make tracking a breeze.
Sales Orders, Invoices, and Sales Receipts
You’ve probably heard of sales orders, invoices, and sales receipts, and have probably dealt with one or all of the above. But what purpose do these documents serve, and how exactly do they differ from one another?
A sales order is a written request that a customer makes for one or more of your products. A sales order represents a payment made but not necessarily a deduction to your inventory, as you haven’t yet had a chance to fulfill the order. Sales orders are common in retail businesses, where there’s very little time and variation between what customers ask for and what they receive. When your customer clicks “check out” on your website, and enters their credit card information, they’re filling out a sales order.
Unlike a sales order, an invoice is an order that is intended for the purpose of requesting payment. It lists the activities performed or the cost of individual materials or components, and gives a total cost for the finished product. Invoices are a little less common in e-commerce business models, but you may use invoices if you produce customized products.
The invoice is delivered to the customer after completion of an order, when the products have been received or services have been rendered.
If your e-commerce business produces custom furniture piece for example, customers may communicate directly with you instead of filling out a sales order. Through phone calls, emails and/or text message exchanges, you might work with the customer to determine the materials, dimensions, and budget for the piece of furniture you plan to build. In this case, an invoice might break down how the individual material and labour costs contributed to the total cost of the finished product.
You can even including shipping costs on the invoice. An invoice will serve as proof of the customer’s requests, and as a receipt that lets the customer see the pricing break down for all products. It also serves as a useful record of how your inventory materials are being used.
A receipt is a proof-of-purchase which is received after the goods are delivered, but it differs from an invoice or a sales order, because it doesn’t serve as a request. Receipts are simply documents that list the items or services purchased and delivered, showing how much the customer paid.
In e-commerce, a sales order or invoice may form the basis of a receipt. You might even package your products with a copy of the original sales order or invoice, to serve as the receipt when your customer takes delivery.
QuickBooks allows you to create sales receipts, sales orders, and invoices, which you can then link with your other accounts to help you track inventory. When a sales order is fulfilled, Quickbooks lets you quickly and seamlessly update your inventory tracking on the cloud to reflect your current inventory levels. You can even set up alerts to let you know when a certain type of inventory is getting low, so you will know when to restock.
Further Reading and Resources
You don’t need to be an accounting expert to run a successful e-commerce business. That being said, it’s a good idea to read up on the basics of bookkeeping for online retail businesses so you will understand what to expect and know what to focus your attention on while you’re busy getting your business off the ground. In case you need a hand, we’ve got short videos and step-by-step instructions to help you learn how to use QuickBooks.
If you want to take a bookkeeping course or learn directly from the pros, QuickBooks can help connect you with a ProAdvisor who has experience in retail accounting. If you’re new to business, it can be a good strategy to talk to professionals and get some advice on bookkeeping basics and how to maintain balanced books.
If you’re just looking to brush up on your own skills, CPA Canada offers region-specific websites to help you find a certified professional accountant who has experience dealing with financial reporting standards in your specific province or region. QuickBooks has many helpful resources for e-commerce entrepreneurs, and CPA Canada also offers business and accounting resources for certified accountants and independent bookkeepers.