The Accounting Mistakes That Can Kill An E-Commerce Business
Multichannel poses challenges when it comes to understanding the totality of e-commerce financials. Legacy software including QBO makes it difficult to have a single source of truth. Without accurate, real-time operational data, growth is impossible, and so is accounting.
Operators need a real-time view of multi-warehouse inventory, stock in-transit, and channel profitability. Flexible accounting solutions should limit human error, and adapt to unique selling environments.
We're sharing the seven most common accounting mistakes made by e-commerce operators.
1. Using the Wrong Methodology
The first mistake is about accounting methodology.
In the beginning, it's easy to operate on a cash model. This means revenues and expenses are recorded when cash is exchanged. As you grow, you need the accrual method to support purchasing and invoicing. An important distinction is that those are not ways of "doing business" those are ways of accounting for how you did business.
Accrual records revenues and expenses when they are incurred, regardless of when cash is exchanged. According to Entrepreneur.com, "The accrual method is required if your business's annual sales exceed $5 million and your venture is structured as a corporation". But for many retailers who keep inventory on their books, the accrual method is preferred to maintain a balanced P&L.
Let's go thru a basic example of Cash v Accrual Recording
You're a home essentials brand that orders $100k worth of inventory in May.
A deposit of $20k is required to place the order in May.
The inventory won’t arrive until July and won't be selling on your site in August.
May - $20k out in cash
June - $10k out to pay for shipping
July - pay the remaining balance of inventory $80k
Accounting on a cash basis would result in "losses":
Loss of 20K in May
Loss of $10k in June
Loss of $80k in July.
Total loss for the 3 month period = $110k.
Now if you were using the accrual basis:
All transactions would go to Balance Sheet categories, resulting in an Inventory Valuation of $110k at the end of July.
When you begin selling the complete opposite occurs with the cash method. Now have revenue with no expenses. But with accrual, the inventory gets reduced only when the product is sold. Sales and Costs match in the P&L.
2. Losing Track of Cash Flow
So where is your money? The second biggest mistake is losing track of your cash, especially during early growth stages. More growth means more investment into inventory. True profitability, is all about Inventory Valuation.
Use a "Where's My Cash" report like the one from Berg Advisors. This report takes the accrual-based profit, transitions it to a cash based profit, and it reconciles directly to the change in the cash from the beginning of the period to the end of the period.
3. Unaccounted-for In-Limbo Inventory
So after cash, the second biggest thing to lose track of is your inventory. It could be on the water, maybe in a warehouse, in transit from one warehouse to another, or better yet in an undisclosed Amazon warehouse.
Mistake number 3 is not counting all of your inventory. The three biggest items that create an accrual-based business are accounts receivable, accounts payable and inventory. In an eCommerce business, the biggest item is always inventory. That means the value sitting in containers on barges, airplanes or FBA.
In the above example, you put a deposit down on inventory and the inventory is on the water. That money isn't actually a P&L profit and loss item, it's a balance sheet item for inventory that's on its way, but that inventory isn't valued until it lands in the US and makes its way to your 3PL.
So before that, it sits on as a deposit for the cash that you've put out. Once it arrives, it goes into your inventory, but there are multiple times that inventories in-transit could get 'lost' so it is very important to have a complete picture of all of your inventory at all times.
PRO TIP: Skubana has a built-in inventory value report that takes into account all in-transit units.
4. Confusing 3PL Fee Structures
To piggyback off the previous mistake up next...number 4 is assuming all 3PLs have a consistent fee structures, and being able to accurately factor that into your accounting records. There is a 3PL for every product, but with each combination comes a new pricing structure. Maybe you need refrigeration, or lock code monitoring, maybe you need an international network of warehouses. As you grow your 3PL costs will grow with you - so it’s important to monitor these accurately.
3PLs also use different software so the first challenge is figuring out how to correctly connect their systems to your existing tools.
3PLs generally have two ways of billing. They will bill you for the month that they are operating in (for storage), but then when the month ends, they will send you a bill for the fulfillment services associated with orders that went out the door. Those "fulfillment fees" are an accrual based item that should be reported on the prior months books so it matches up with the sales that went out the door. Also ask them to audit your inventory and preform regular cycle counts to ensure your books match up.
PRO TIP: Know where you sell. Perform an analysis of the geographies in which you have the highest sales volume. Then strategically position your inventory to lower shipping costs.
5. Forgetting Sales Channel Fees
So we know that inventory and vendor costs are fundamental to understanding true profitability. But another element is the costs associated with selling that inventory. This leads to mistake number 5…
Just like the 3PLs...Every channel you sell on is different. And so are the margins on those channels. Brand operators that forget to include unique marketplace, advertising, storage and shipment fees will lose sight of their margins.
Where and how you sell can impact cost-of-goods-sold and ultimately the success of your business. Legacy software - especially accounting systems - cannot support the multiple endpoints of modern e-commerce businesses. So pay extra attention to the nuances of each channel, warehouse and vendor.
Work alongside your accountant to ensure each detail is appropriately recorded.
Not all accountants are created equal. What we suggest is choosing an accountant that understands the business you're working in. Quarterly reconciliations help monitor the health of your e-commerce business and ensure major problems don't go unnoticed. By using a single-source of truth for your inventory, sales channel, vendor and fulfillment data you can reduce the spread of errors. Once that information is reliable, using automation can further reduce error rates, while lowering overhead.
Without true inventory value, you won’t have flexibility over:
Like in any business, e-commerce decisions are based off of numbers that are constantly moving. Don't guess when it comes time to making a decision, ensure you have the correct data to make the correct decision.
7. Stop Doing it Manually
The days of spreadsheet accounting are over. Your data is constantly changing. If you are working off a static spreadsheet, your data is already outdated. Without accurate data, you don’t know the true value of your inventory, COGS, or when to issue P.O.s
Gina Tirelli manages Partner Marketing initiatives at Extensiv, the leading retail inventory and order management software for D2C brands and marketplace sellers looking to unify and automate their multichannel operations. When Gina is not marketing ecommerce software, she likes to spend time outdoors with her dog Elli.