The Ultimate Ecommerce Accounting Guide

If only running a successful ecommerce business just required selling a lot of product…

Operators who’ve been around for a decade might remember the famous Shoes.com. They were lauded as a top Canadian ecommerce company in 2016 and were filing for bankruptcy by 2017 (earlier that year, they’d been talking about an IPO). It had nothing to do with sales; those were great. It had everything to do with finance.

In short, Shoes.com banked so hard on “good customer service” that they accepted returns left and right and did not factor them into accounting. Furthermore, they got behind on provincial taxes. This delayed payments to service providers, which led to lawsuits and then bankruptcy.

Unfortunately, as with most businesses, a perfectly successful ecommerce business can crash and burn if they don’t account for costs. As a founder, you need a firm grasp of your finances and bookkeeping so you make money on every sale.

We have a bit of experience in this area. At FlowFi, we quickly connect ecommerce operators searching for financial help with industry-specialized experts. And we do it through one of the most advanced matching algorithms on the market today.

We sit on top of every interaction between clients and experts; therefore, we’re privy to hundreds of ecommerce financial problems every day.

We created an in-depth look at the key accounting considerations for ecommerce businesses, strategies to follow, and common pitfalls to avoid. Partly, to help operators like you understand how complex e-commerce finance can be and convince you to consider hiring an ecommerce accounting expert.

How to Master Ecommerce Revenue Recognition

First, what is revenue recognition?

Revenue recognition is when you record sales revenue in your financial statements. 

Many new ecommerce operators get revenue recognition wrong by recording sales revenue immediately when each new purchase comes in on Stripe. This is an easy way to wildly miscalculate your profits.

Just because the cash hit your account doesn’t mean the sale was made. A customer can request a refund at any time, or something can delay shipping. Maybe one of your carriers hikes prices drastically one week later when you ship. If that happens, you could register a profit that is actually a loss down the line.

How to manage revenue recognition

Just as you confirm an order only when it’s shipped and delivered, you should recognize revenue only when the sale is complete and the product is on its way to the customer. 

This specific type of recognition process is known as accrual accounting.

How to Manage Ecommerce Inventory Management and Valuation

Your inventory management system is one of the most important parts of any ecommerce operation. You need to know what’s in stock, where it is, and how much it’s worth to ensure smooth operations and finances.

The common mistakes ecommerce operators make, not counting stock and switching between valuation methods:

You should keep a running count of everything in your warehouse (or garage) along with when it entered and left. This is very easy as a small business but starts to grow out of control as you grow. All professional e-commerce warehouses eventually throw barcodes on everything that enters the warehouse and hand-scan the goods.

This method, combined with good warehouse management software, will let you track your goods and keep count without giving you a headache.

Now onto valuation.

There are three common inventory valuation methods:

• FIFO (First In First Out) - This is the most intuitive and widely used method. It assumes that the first products you sell are from the first products bought. This is preferable for selling perishable goods, though it can exaggerate profits, as costs on older goods tend to be lower.

• LIFO (Last In First Out) – This model assumes the most recent products sold are always the most recent products you’ve received. This generally can only be used for non-perishable goods and is mainly done for the tax benefits. You prioritize the more recent goods, which, due to natural price inflation, almost always cost more to buy than the old goods. Obviously, you’ll eventually have to sell the cheaper, old goods, but you can put off the tax bill a little longer with LIFO. It’s worth noting that while LIFO is common in the US, tax authorities in many other countries don’t like it.

• Weighted Average – This means that you maintain a running average for the costs of all the goods you have and simply calculate the cost based on it. This process is used to simplify operations (you don’t need to track inventory as tightly) as well as avoid profit or loss spikes.

Your chosen e-commerce system must support the accounting style you’ve decided to use, and you should never switch if you can help it. Fortunately, many third-party warehouses can also onboard you to their own management software as well.

Other important note: for taxes, once you start filing based on LIFO or FIFO, you need to ask permission from the IRS to switch back. When deciding, it’s a case where you’d assuredly want to contact a tax expert for an assessment.

How to Manage Cost of Goods Sold (COGS) for Ecommerce

COGS is the total cost of getting an item from your supplier to your customer’s door. It’s essential for calculating your gross profit.

COGS includes all direct costs attributable to the production of goods sold by your business. For e-commerce, this typically involves the cost of products, shipping, and handling.

That means if you sell T-shirts you bought in China, COGS would include base goods + international shipping + taxes + local warehouse fees + platform fees + last mile + labor for each one. 

As you can see, these fees start to add up quickly; this is why most ecommerce businesses wait to add complexity before they add scale. This is also why many ecommerce businesses often grossly overestimate their profits.

To manage COGS: Make sure you track every single cost and split them across all products they apply to. That’s especially important for the oft-forgotten labor cost.

The basic formula is always: Beginning Inventory + Purchases - Ending Inventory.

Remember, this is the formula for what you are losing against your revenue, not making.It's important to note that indirect expenses like marketing, rent, and administrative salaries are not considered COGS. They are operating expenses.

How to Manage Sales Tax For Ecommerce

Ecommerce businesses face increasingly difficult tax obligations. You can pay different sales taxes depending on the states or countries you sell in or even have a warehouse in.

If you don’t track taxes correctly, you can end up with a surprise letter from the IRS sitting in your mailbox.

How to manage sales tax:

Many common ecommerce software systems can help you monitor sales tax. However, as you expand your ecommerce business (usually when you contract your first warehouse), you will likely need to consult a tax expert.

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At FlowFi, we can connect you with an e-commerce-specialized tax expert in just 48 hours. Check out our services page to see what we can help you with and to sign up for a free consultation.

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How to Manage Payment Processing Fees For Ecommerce

Payment processing fees are simply the fees charged by payment processors like PayPal, Stripe, or credit card companies for handling transactions.

There isn’t much of a trick to managing payment processing fees; you just need to make sure they are being tracked because they add up.

Stripe takes its famous 2.9% + 30¢ for domestic transactions, and PayPal costs 2.99% + $0.49. Sometimes these apps will make you dig for their monthly fee reports too.

The difference in price between PayPal and Stripe doesn’t matter when you sell 100 $10 items per month ($59 to $78.9). When you sell 10,000+, you’ll start to notice a big difference. $32,000 is much less than  $34,800.

How to Manage Return and Refund Management For Ecommerce

Managing returns and refunds is pretty much 90% of most ecommerce businesses’ customer service processes. But, just like Shoes.com above, if you aren’t tracking them correctly, you are likely hemorrhaging money. Returns and refunds only benefit a business as an offset to its taxes.

The two most common financial hiccups for returns:

• Revenue Impact: Not adjusting revenue for returns can overstate your income.

• Inventory Issues: Failing to account for returned items can distort your inventory records like COGS.

Tips for managing return revenue:

Inventory & COGS Adjustment

• Any usable items need to be restocked: Any of the restocked items should then be debited to inventory and COGS.

• More importantly, you should write off damaged items to offset your taxes. This is a special type of deduction that you’ll likely want to talk to a tax expert about.

Logistics & Fees

• Record return shipping labels or restocking fees as operating expenses. Again, this will give you a tax benefit next year.

• Account for payment processor refund fee losses separately. Otherwise, it will start to confound how much you are really making.

How to Manage Shipping Costs For Ecommerce

Shipping costs are the expenses incurred to send products to customers. These include international shipping, warehousing, and last-mile trucking prices.

Every ecommerce business runs into this dilemma at some point: do they absorb shipping costs or pass them on to customers?

Here’s the general rule:

• If you plan to sell goods in high volume, factor inbound shipping to your warehouse as part of COGS. Then factor outbound shipping to customers as part of operating expenses. Customers will balk if they have a substantial shipping cost added on to a low-priced good.

• If you sell a smaller number of pricier products, feel free to pass on shipping costs to the customers. Most don’t have a problem paying a higher cost if it is only a small percentage of the goods purchased.

How to Manage Marketing and Advertising Expenses For Ecommerce

You may want to check out our more in-depth blog: how to do accounting for advertising.

These are the costs associated with promoting your ecommerce store and products. These can include online ads and promoting your business on online marketplaces like Shopify or Amazon, as well as influencer marketing.

The most important part of doing accounting for advertising:

All advertising and promotional activities need to be calculated in terms of their ROI. Put simply: How many purchases did you receive per dollar spent?

You want to at least be breaking even to justify advertising costs.

How to Manage Financial Reporting and Analysis

Financial reporting is your business’s health check-up. 

These are the normal documents an ecommerce business needs for accurate reporting:

• Balance sheet – A report of all assets owned (that includes inventory, cash, and equipment) balanced against liabilities (debts owed to outside parties; usually this includes delayed payments to suppliers/warehouses, etc.) plus share ownership.

• Income statement (profit and loss)  – This is simply subtracting your costs from your profits.

• Cash flow statement – This is a statement regarding how much money your business can expect to have free in the bank at any given time. It is complicated enough to calculate that it deserves its own blog. Cash flow accounting is one of the most requested services we receive at FlowFi.

How to manage ecommerce financial reporting

Most ecommerce financial reporting is complicated enough that you are going to want to consult with an expert bookkeeper. An ecommerce accounting expert can work with you on a part-time basis once or twice a month to make sure you’re on track. They can also help you set up software and other systems to make sure you are accurately tracking inventory.

Needed to Get Your Ecommerce Accounting In Order Yesterday? Consult a FlowFi Expert.

If you haven’t noticed yet, accounting for ecommerce is hard. Hard enough that almost every ecommerce business eventually gets an accountant either on staff or as a consultant.

Already behind on your books? That happens to everyone too. We created FlowFi to connect ecommerce operators with industry-specialized experts quickly and based exactly on your needs/pricing.

Here’s how it works:

• You sign up for a quick, free 15-minute assessment call with our team and fill out a questionnaire.

• Our team puts together a plan based on your needs, then uses 50+ data points from our assessment to match you with one of hundreds of highly vetted accounting experts based on your pricing, complexity, and even work style.

• Your expert onboards to your business in days and helps you get your accounting in order.

Ready to get started? Fill out the form below, and we’ll send you a message within hours.