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As an eCommerce business owner, you have a lot on your plate, from sales and marketing to sourcing new products and customer service. While some things you can learn by doing, there is one area where making mistakes can be quite costly. That’s accounting.
Fortunately, there are tools and resources available to help eCommerce merchants streamline their accounting and avoid costly errors.
In this post, we’re sharing the top 7 eCommerce accounting mistakes that we see business owners make as well as how to prevent them.
Recognizing income based on net deposits and not true sales figures
Sales are growing steadily each month.
You are having to order more and more inventory.
But, your bank account balance is flat – if not declining. You may even be struggling to pay bills on time.
This is an all-too-common scenario that many eCommerce entrepreneurs struggle with.
“One of the biggest challenges I’ve found with our business predominantly being eCommerce is that as soon as money comes in, it goes straight back out to invest in inventory. So cashflow is always a significant issue.”Hayden Brass, Co-Founder and Managing Director at eCommerce company Zea Relief.
“Before I hired Bean Ninjas I was running ‘blind financials’ as dark as the moonless sky, I frequently used top-line revenue numbers to give me a sense of what my north star looked like. Wrong. Until I decided to hunker down and reconcile my books, which rarely happened, I frequently found that the light in my sky was actually an oncoming train in a tunnel of financial pain. Thanks to the Bean Ninjas, I now have up-to-date income statements and balance sheets each month that allows for a much truer north star reading—let’s just say I have fiscal astronomers on my team now that makes all the difference in the world and I don’t have to worry about scrambling to create financial reports to get a pulse on my business.”Derek Dodds of Naked Armor Razors.
It is easy to fixate over net sales revenue instead of the actual sales figures. Many vendors, like Shopify, will post direct deposits to your bank accounts for the total sales less applicable fees. These fees include shipping, warehousing, or handling and depend on the vendor.
When you look at just the amount posted to your bank account, you’re missing out on the total gross revenues as well as expenses, which can cause cashflow issues.
Instead, it’s a best practice to login to the applicable sales channel partner website and download your sales reports. Once you download the reports, you can make the adjustments to recognize the true sales and fees applied. This will allow you to have predictable cash flow and be prepared for when unexpected things happen.
In Brass’s case, he wanted to gain a better understanding of his business financials, so he signed up for the online Bean Ninjas Financial Literacy Training for Xero Users course led by Bean Ninjas founder Meryl Johnston.
“Getting the opportunity to work directly with Meryl and learn from her and her experience and also the various templates that were provided throughout the different weeks and templates that we don’t normally have access to, you really get a better understanding of where your business is positioned financially,” says Brass.
Not adjusting items sold appropriately to reflect correct inventory levels and cost of goods
Inventory levels play a big role in your P&L, balance sheet, and cash flow forecasting. This means that mistakes in inventory valuation will carry forward from one accounting period to the next.
A simple mistake in inventory that carries over each month means that your reported business assets and cost of sales could be wildly inaccurate.
Regular stock counts can mitigate this problem. A physical check of your inventory is important to make sure the count you have in your accounting system matches the true inventory you have on hand.
For those with a large amount of inventory at any given time, this is easier said than done. Cloud accounting software apps can help. For instance, Xero has an open API that lets you link to inventory apps to help with this. Understanding your inventory levels can help you with forecasting to determine when you need to place another order as well as ensure that you can meet the anticipated demand for the following months.
Using spreadsheets or other manual processes instead of cloud accounting software
In our experience, we often see business owners who don’t like bookkeeping, put their heads in the sand when it comes to their business financials.
That’s a problem that eCommerce entrepreneur Will Roman at Chisos Boots can relate to.
“I wish I would have known what a pain in the ass it would be,” said Roman. “Ensuring that your bookkeeping team has full context behind the intention of your purchases is essential to ensure accurate reporting. Put in the upfront effort to share insight about what you’re attempting to achieve and how their reports can further that aim. Have a professional team to guide us through that process has been invaluable.”
This is a massive risk and can jeopardize the business you’ve built. If you want to run a successful eCommerce store, you need to have an accounting system. We recommend using cloud accounting software, such as Xero.
In fact, in one memorable experience, a business owner told us, “The accountant looks after that, so I don’t need to worry about it.”
Months went by, and we later learned that they received a letter from the tax department saying they hadn’t paid their taxes for the past two years. They were penalized with a massive fine.
If you don’t want to be shocked by a staggering bill from the IRS, then you need to understand your finances.
Fortunately, it is easier than ever to not wind up in this unfortunate situation. You can use cloud accounting software, such as Xero, to do the heavy lifting for you. Plus, you can integrate with tools, such as Avalara or Taxjar, to identify any potential tax liabilities across your past sales.
Pro Tip: Check out this post, which compares the most popular cloud accounting software options to help you decide which one is best for your business.
Using personal bank accounts for business purchases
Keeping your business and personal transactions separate is the best practice. However, it’s still a common mistake that eCommerce business owners make. These mistakes might be innocent, but they can quickly become an accounting nightmare and a liability if you were to be audited.
For example, when you make a business purchase online through a merchant, you have a personal account through already, it’s easy just to order using your existing payment details. It’s similar to picking up office supplies while you’re at the store and throwing them in the cart with the rest of your groceries. You might not think twice before paying for it all on the same personal card.
Here are 3 ways to keep your personal and business finances separate that will save you time in the long run:
- Set up a business bank account if you haven’t already. Make sure each business transaction goes through this account. Do not use it for personal transactions. Your business account is just that – a business account.
- If you make credit card purchases, then make sure you’re using a small business credit card. You can connect your card directly to Xero to easily track transactions and record them as expenses.
- Set up a recurring process for receipt management. Whether you use a tool like Hubdoc or Expensify or manage this process directly in Xero, you should set aside time on a regular basis (ideally monthly). This ensures that you don’t have a mountain of receipts to go through come tax time.
Failing to set aside time to do bookkeeping and review financial reports
Setting aside time to review your reports and bookkeeping is crucial. Ideally, this should be done once a month. I often see 2 main reasons that business owners fail to do this.
The first is that they don’t have a system in place for reviewing expenses. Without a system, you could end up staring at spreadsheets and spending hours organizing receipts at year-end.
Another set back to reviewing monthly reports is a simple lack of time. Business owners are often stretched thin. They wear many hats, and there’s always something that demands their attention. Monthly reports can be pushed on the back burner, and the longer they go without being reviewed, the more the work piles up, and the more likely that mistakes will be made.
In addition to setting aside time for bank reconciliation and expense tracking, there are three reports that you should monitor.
- Profit and loss statement (i.e. P&L)
- Balance sheet
- Cash flow forecast
For example, let’s say your P&L showed a significant drop in profit month over month. Further investigation might show that the added expense is acceptable due to hiring a new staff member. Or it could show that staff expenses hadn’t changed, but revenue had. This would require a deeper dive into why revenue had dropped and if changes needed to be made to improve profit margin.
Incomplete chart of accounts
Another mistake eCommerce owners make is not customizing their chart of accounts. A chart of accounts is basically a list of the individual accounts that make up a company’s summary of transactions. It covers everything from assets and liabilities to your equity, revenue, and expenses.
With a chart of accounts, you will be able to see all the money coming in and out of business, effectively manage your inventory and maximize the selling potential of your business.
Taking the time to set up your chart of accounts and establish categories for your areas of spend will save you time when recording expenses. It will also let you look at each category to show you how they fit into the big picture. You can think of these categories as file cabinets for each area of spend.
For example, each time that you see a charge for Klaviyo, you’ll know that it should go into your marketing software category. Putting expenses into the correct category helps you see where your money is being spent.
Errors in your chart of accounts lead to a misunderstanding of where your money is being spent.
Focusing only on inventory costs and not tracking overhead expenses
As mentioned above, it’s important to have an accurate count of your inventory. However, you shouldn’t focus solely on your inventory and forget other overhead expenses. Overhead expenses include marketing, administration costs, staffing, etc.
For example, if you hire someone to run Facebook ads to direct traffic to your store, the cost of the person you hire along with the ad spend needs to be reported as marketing expenses. You could have a record sales month, but subtracting the costs could reveal that you only broke even. If you were only looking at inventory costs in this example, then it could look like you were coming out ahead, and you might continue running the same ads at the same item price without any changes.
In this case, you might realize that selling your item at $20 each doesn’t get any profit with the conversion rate of your Facebook traffic. You would need to adjust either your ads or your pricing to ensure profitability goals are achieved.
Where to from here?
In sum, these are seven of the biggest eCommerce accounting mistakes that we business owners – especially first-time owners – make. Being proactive and setting aside time each month to focus on bookkeeping processes and going through your financial report can keep your business on track.
If you are looking for more in-depth accounting best practices, check out our free Xero eCommerce toolkit.
This is a guest post contribution by Wayne Richard. Wayne is a management accountant who forged a 15-year career with tech heavyweight Hewlett Packard before starting his own cloud accounting firm in Tucson, Arizona. Fate (and the Internet) brought him to discover Bean Ninjas via a blog post. Two years later and Wayne’s involvement with Bean Ninjas had grown from a blog comment to a contractor to equity partner.