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Accounting is one of those aspects of a business that we would rather not deal with. We find it shrouded in mystery, boring and complicated and often times we believe that it’s best handled by someone who has studied accounting. This may be true and it’s possible to just stack up your receipts in a box and hand them over to a stranger who’s more familiar with accounting. The problem that arises here is that you will also be handing over financial control of the business which can be risky for your overall success.
On top of that, you will have to pay a pretty penny to the stranger to get your accounting sorted out. If you are looking for business growth, it’s in your best interest to understand a bit of accounting. We can tell you that it’s not as complicated as you may think and that day-to-day management of your finances doesn’t require the help of an accountant.
In the event that you hire a professional to handle your accounts, you will still need to familiarize yourself with the basics. Not only will you be able to carry on an intelligent conversation with your ecommerce accountant but you will also have the ability to understand and question what the person is telling. It’s your business after all, and your livelihood at stake.
We have listed below 10 accounting basics that will cover all you need to know about accounting in your business and help you ask the smart questions.
- Get an Accounting Software
We love calculators and keeping financial data on an Excel sheet but this won’t work. You are better off getting an accounting software. Freshbooks is good for people who run e-commerce businesses while those who use Shopify can benefit from the many accounting software apps available in the platform’s app store.
If you feel a little unsure about the software you need, try a free one or look for one that offers a 30-day free trial.
Naturally, the best option will be the one that suits your business and your preferences. Be sure to select a system that does more than creating invoices or generating reports. Get one that will also track costs, inventory, and sales. These are vital to your business.
Additionally, regardless of where you pick your software from i.e. Shopify or elsewhere, choose software that syncs directly to your business. Your life will be a whole lot easier.
- Track Your Cash Flow
This would be a good time to get a separate bank account for your business if you don’t already have one. It’s important to know how much money your business is making and watching your cash flows is the easiest way to do this.
If more money is coming in than it’s going out, it means you are doing well, right?
Carefully observe the timing of money coming in and the money going out. To illustrate this, imagine a scenario when you are expecting $1 million to come in next month but you have bills or wages to pay tomorrow- how will that play out? Any holds that you have on your account should be kept in mind.
How do your customers pay you? Have any of them placed any hold on the money? What kinds of time delays do you experience from the moment a client pays to the time money actually hits your account? Is it a three-day delay or a five-day delay? It’s important to have this information on hand so you can know how soon you can spend the money.
Keep track of expected expenses every week and how much money is coming in. If the amount of money that you need to spend exceeds what’s currently in your bank account plus what’s expected to come then you know that there’s a problem.
Here are some tips to help you improve your cash flow:
- Avoid paying for anything much earlier than you should. If a payment is due in 30 days then pay it in 30 days.
- Offer your customers monthly payment plans to guarantee the flow of money into your account.
- Ensure your business bank account has a reserve for the “just in case” moments.
- Keep your cash flow statements simple. You don’t need complicated, huge or technical statements.
- Determine How Inventory Will Be Counted
Those who sell services can ignore this step.
Inventory here refers to the products that your business sells. It also refers to all the materials needed to build that product and should include costs incurred for packaging or wrapping the product.
You will need to determine the minimum volume of inventory needed on hand for you to run your business efficiently and keep an eye on this inventory so that an order for more is made before you reach run out of the product. Running out of inventory is one of those business fiascos guaranteed to bring you losses.
At this point, you may be wondering how inventory is tied to accounting basics. Well, inventory equals money. You spend money to buy the materials (inventory) that make up your products and the way to get your money back is by selling the products. This means that your money is tied to your inventory. As long as you have inventory in your warehouse, store, garage, apartment etc., money is tied.
- Know What Your Cost of Goods Is
The cost of goods sold can be described as the expenses that are directly connected to the products you sell. In other words, it’s the inventory you have sold and how much it cost you to make that inventory.
If say you in are the business of selling widgets. When selling one widget, the actual cost of parts and whatever else it costs to build the widget will be the cost of goods sold. If parts cost you $50, labor $25 and packaging $10, the cost of this widget is $85.
Now it may not be as simple as we have illustrated above since you may purchase lots of widget parts at different prices plus you may also have several people on staff earning different salaries and adding together all this may be quite confusing. In such a scenario, using the weighted average will be the easiest way to go around this.
Keep in mind that anything that’s directly connected to your product and increases in cost when you build more products should be counted in the cost of goods sold. If say your employees are paid for every widget they build, then include their labor.
However, if your employees earn a flat hourly rate regardless of whether they make a widget or not, their labor will not be included in the cost of goods sold.
Your “Gross Margin” is the retail price of your product minus the cost of the product. It’s important to note that this is not profit; rather, it is a way of letting you know how much you are making on a single product before you factor in all other expenses. It’s possible for things to get complicated if there are different sales conditions for different costs.
- Calculate All Other Expenses
Having established that your costs are directly connected to the sales volumes, we need to look at and understand the impact of everything else and how much it’s costing you.
Expenses that remain static whether you sell more or sell less are known as “fixed expenses.” An example of this is (where applicable) the monthly rent. The rent amount is fixed and will not change whether your business sells a million products or none at all. Fixed expenses are not considered part of the cost of goods and they are not factored into the gross margin. However, these expenses will affect your cash flow and your profits.
Some of the common fixed expenses include:
- Property Tax
- Interest on loan payments
The reason these expenses are categorized as ‘fixed’ is because of the fact that they have to be paid for even if your business doesn’t generate any sales. A point to note here is that the word “fixed” doesn’t mean that the cost of the expense is the same every month.
Utilities, for example, fluctuate a lot and you may find that the amounts will differ from one month to the next or from one season (Winter) to another (Summer). However, by accounting terms it’s deemed as a fixed expense.
If your fixed expenses change from month to month then it’s wise to use an average amount when budgeting.
- Find Out What Your Break-Even Sales Are
Budgeting and planning are crucial to a business since it’s not only important to know how much profit you made last month but also how much to expect in the coming month, and the next one as well.
Break-even sales amount can be described as the amount of sales dollars your business needs to make in order to cover all its costs. For instance, if your ‘fixed costs’ total $5,000 per month, then the business needs to generate sales that cover the cost of production (and labor) and an extra $5,000 just to break even i.e. not make a profit or loss.
- Track Your Sales and Profits Before Tax
Having figured out how many pieces you need to sell in order to break even, we will now look at tracking your sales.
Tracking sales helps you manage your money and is valuable for assessing early on if issues will arise.
Let’s assume that you need to sell 5,000 units in a month just to break even. By the 15th only 1,500 units have been sold. Now, if you are tracking your sales, you will have picked this up. Seeing as how you only have two weeks left until the end of the month, you will need to drive up your digital marketing efforts in order to meet your goal.
If you choose paid marketing, always ensure that the cost is factored into your budget and that the costs make sense. There’s no need of spending $2,000 in marketing costs just to make $1,000.
Google Analytics is a great tracking tool. Link it to your e-commerce site and track your sales. Your e-commerce site can benefit from the Google Analytics plug-in which makes access easy.
- Set Up Proper Tax Rates for Customers
Like it or not, taxes are unavoidable and in some cases, they can be quite complicated. If your business sells different products or services to many people all around the world, it would be a good idea to consult a professional for this.
Fortunately, the systems in use today are quite smart and it’s likely that your e-commerce software will have the ability to handle most of the work for you. Once you flag a product or service as taxable and the customer inputs their address, the software will calculate the tax payable.
Shopify businesses can go to Tax settings to set this up.
- Paying Your Taxes
Now that you are collecting the tax, you also need to pay it to the relevant authority. The applicable tax rules will depend on your location but you can expect that you will be required to submit as much tax as you have collected.
Recognise and set aside the money you have collected as tax. It’s not your profit or any such thing otherwise you may find yourself in trouble when you’re filing returns. Shopify is one of the online shopping services that lets you include tax in the sales price.
If you are unwilling to include tax in your prices then make sure that the system allows you to run a tax report. The report will help you identify how much has been collected in taxes so you can keep it aside.
- Understand the Balance Sheet
We have come to the tenth accounting tip, having covered the cash flow statement, the income statement and a lot more. Let’s now look at the balance sheet. A balance sheet helps you track your company’s long-term financial health and helps you see how the company is performing.
An income statement is sort of a snapshot in time while a balance sheet gives you the bigger picture. The balance sheet comprises of assets, liability and shareholder’s equity.
Assets are the things that hold value in your business such as cash in the bank. Liabilities are the debts you owe. Equity is what the owners (partners/shareholders) have put it. It’s the difference between your assets and your liabilities.
For example, if you bought a car worth $50,000 and you still owe $30,000 on it, it means that your asset is $50,000, your liability is $30,000 while your equity is $20,000.
If you were to sell the car today for $50,000; you would get $50,000 in cash, pay off $30,000 that you owe and keep $20,000 in your pocket. So, you have equity and by selling the car today you will make money. That’s an illustration of how the balance sheet for your business should look like.
These ten accounting basics should reflect in your day-to-day operations as well as the month-to-month activities. Stating with basic accounting software will simplify your life and you can always upgrade once you learn the ropes.
Keep in mind that, “cash is king.” Keep a close watch on your cash flow which can be managed on a weekly basis unless your cash reserve is big and builds up fast. In this case, you will need to manage it more often.
Next, understand your sales, profits, and expenses i.e. your income statement. Know how much money you are making weekly, monthly and annually. Plan for taxes and if needed, automate your e-commerce site to collect the tax for you. Remember to keep this money aside to be paid to tax authorities.
Lastly, create your balance sheet. You can also have your accounting software do this for you. You will be able to know the financial health of your business by looking at the balance sheet and know whether your business is in too much debt.