E-commerce accounting can be tricky, but once you know a few tips and tricks, you will be up and running in no time. Whether you have dedicated e-commerce accountants or not, you will still need a basic understanding of your software and your accounting requirements.
E-commerce entrepreneurs will undoubtedly need specialised e-commerce accountants as they scale, but whether you have reached that stage or not, you will still be required to file accurate annual accounts. Follow these steps to blitz through the basics.
1. Get Xero
All entrepreneurs should set up comprehensive accounting software as they are setting up their business. For e-commerce businesses, Xero is the best choice, as it is built with e-commerce in mind. Xero has plentiful integrations and in-built features that are designed to make tracking your e-commerce business’ accounts as straightforward as possible.
2. Cash flow is everything
As all e-commerce accountants will tell you, cash flow is the lifeforce of your business, especially in its early days. It does not matter how profitable your e-commerce business is if you don’t have the resources to keep it running.
Download Receipt Bank to quickly and easily store receipts by scanning them with your phone. They will be uploaded to Xero and the data accurately pulled and stored in your accounts.
For additional ease in tracking your incomings and outgoings, we strongly recommend setting up a dedicated business bank account.
3. Understand your inventory costs
There are numerous ways to do so through Xero, but you must keep an eye on stock levels and account for storage costs. The longer stock sits in storage, the more it will cost you.
You want to keep enough stock on hand that you will never miss a sale, so be sure to increase your stores before any seasonal activity. Yet you must be mindful not to tie up too much cash in stock that will be slow to move (see point 2).
Of course, you may be using print on demand or drop shipping for some or all of your products, removing many of these issues.
4. Cost of Goods Cheat-sheet
Generally, for e-commerce, your cost of goods sold will look something like this:
Postage & Packaging £6
E-commerce platform fees £1
Stripe/PayPal etc. £1
You can create an average cost of goods by looking at a month of transactions. If you sold three orders and their cost of goods was 1 item at £53, 1 item at £64 and 3 items at £47, you would add these together and divide by five to get £51.60 as your average cost of goods.
Factors to look out for include free shipping thresholds and varying prices of shipping. Of course, Xero will track these for you to make the cost of goods simple to calculate.
6. Fixed Costs and Runway
You may have heard of the concept of runway. The length of your runway is how long your business could survive if income were to drop to zero. This is accomplished by having a clear idea of your fixed costs, such as electricity, e-commerce platform subscriptions, Xero subscriptions, website hosting etc.
Again, this will be clearly listed in Xero, but it is essential to know what your fixed costs are, and ideally start to build yourself a buffer of runway in case of events out of your control. The recent COVID-19 situation is a stark reminder that even the best planning can be laid to waste, so knowing what you must cover and how it will be covered is essential.
7. Break-even point
Even if you have a healthy 3-6 month runway put aside, you need to learn to ignore it. That is for emergencies only.
E-commerce accountants will always be keen to discover your break-even point, whatever stage your business is at. Your break-even point is how many sales you need to make to cover all your costs for the month.
This may be trickier to calculate if you sell items across a range of price-points, but you should still have some figures to work with. For example, if you sell a product at £10 and another at £100, and your costs are £1,000 then you would need ten sales at £100 but one hundred sales at £10, or 5 sales of £100 and 50 sales at £10. Again, you can take an average over your products if they are varied in price.
You can calculate your break-even point as follows:
Revenue per unit – variable cost per unit = margin
Fixed costs/margin = break-even point
This will give you an amount in units that you need to sell each month to satisfy your fixed costs. Additional revenue can be put back into developing the business, paying your income and building runway.
7. Before-tax Profit
Once you have all these costs figured out you can use them and Xero to look at your before-tax profits. Just remember that profits are not cash; they are informative markers on your business’ health. E-commerce accountants such as ourselves will explain how important it is to keep one eye on profits and one on cash to avoid issues once your tax bill arrives.
8. International taxes
While we recommend all e-commerce entrepreneurs consult with an e-commerce accountant in every country they sell in for tax purposes, Xero will allow you to track your international VAT rates across all your e-commerce platforms. Once you have received advice on the right VAT rate for your business in each locale, enter the details into Xero and it will keep you informed on this tricky area of e-commerce accounting.
9. Tax Time
We’ve looked at before-tax profits, but it is inevitable that a tax bill will be arriving. Speak to your e-commerce accountant and find out what size of bill you can expect (Xero will also give you an indication) and make sure to accrue it in your monthly costs. Again, this is crucial for cash flow purposes and will prevent you from breaking into a cold sweat when you see that HMRC letter arrive!
If you need help setting up Xero, including if you are moving over from another accounting system, or would like to discuss your e-commerce business with us, we are happy to help. Our team of specialists are always available to aid your e-commerce business is reaching its full potential.
The best time to act is now.