If you're the owner of an e-commerce business, it's important to have a deeper understanding of your numbers to grow your business into a healthy, profitable one. E-commerce accounting might not be fun, but it's a painful necessity for you to comprehend the health of your company, plan for future growth and file your taxes accurately.
Here’s what you need to know about e-commerce accounting, so you can always stay on top of things.
What Is E-Commerce Accounting? Is It Similar to Bookkeeping?
While accounting and bookkeeping sound interchangeable, they are not synonymous. Instead, they work together to complement each other.
Bookkeeping involves the daily recording of your transactions and financial documents to organise your business finances. This information is then passed on to the accountant.
Think of accounting as the process that lets you review your business’s financial health, involving reports, taxes and figures for growth planning. Some may think that the traditional accounting method would apply to e-commerce businesses, but that would not suffice.
Since e-commerce is a business that never sleeps, it involves unique aspects that should be recorded for accuracy and smart financial management.\
2 Types of Accounting To Keep a Record for Your Business
A financially savvy business runs on a set of processes and a well-defined system. Take time to understand the types of e-commerce accounting and determine the best solution for your business.
The main difference between the following two accounting systems lies in the timing - when you record your revenue or expenses.
Cash Basis Accounting System
Cash basis accounting is the process of recording your revenue or expenses when you pay or receive money. Businesses that employ this method recognise revenue and expenses only when the money arrives or leaves their business bank account. These include government agencies, non-profit organizations, community associations and small service businesses since they do not sell on credit and pay bills when they are incurred.
Advantages of Cash Basis Accounting System
- Its simplicity easily reflects your finances available on hand
- Simpler option to calculate GST, but businesses are required to use the accrual basis accounting system under the Hong Kong Financial Reporting Standards (HKFRS) and Small and Medium-Sized Entities Financial Reporting Standards (SME-FRS). This is especially important In Hong Kong, as every company would be audited by an HK Certified Public Accountant (CPA).
Disadvantages of Cash Basis Accounting System
- It is inaccurate and could reflect only your profitability if you have yet to pay your bills
- Poses challenges when it comes to management decisions since it only provides a day-to-day overview of your finances
Accrual Basis Accounting System
Accrual basis accounting is the process of recording your revenue or expenses when you get billed or send an invoice. Businesses that make use of this method acknowledge revenue as soon as the customer is invoiced. When the business receives a bill, this is acknowledged as an expense even if the payment will not be incurred for another month.
Advantages of Accrual Basis Accounting System
- Provides a holistic view of your business finances and performance
- Enables more confident decision making
Disadvantages of Accrual Basis Accounting System
- It is a much more complicated process since you have to keep tabs on invoices and your business bank account
- You may have to pay income tax before your customer has made payment to you
Here’s how accrual-based accounting works:
|Week 1||+HK$ 50,000 (online sale of furniture)||Immediate||-HK$ 10,000 (platform fee)||Pending|
|Week 2||+HK$ 25,000 (sale of apparel)||Pending||-KK$ 9,000 (cost of shipping)||Immediate|
|Total||HK$ 75,000||N.A.||-HK$ 19,000||N.A.|
Bi-weekly income: HK$ 56,000Sales
From the above table, company XYZ made HK$ 50,000 in week 1 from their online furniture sale. The payment was immediately received by the company’s business bank account. Subsequently, in week 2, XYZ saw HK$ 25,000 in the sale of apparel, but the payment has yet to be cleared. However, this transaction should still be noted at the point of sale.Expenses
While the HK$ 9,000 shipping costs from shipping apparel were immediately taken out from the company’s bank account, the HK$ 10,000 platform fee from the sale of furniture will not be due until the next 30 days. This means that the HK $9,000 will remain in the company’s bank account temporarily, but should be recorded as an expense at the point of sale.
If you are just getting started, the accrual basis accounting system might be difficult to comprehend. However, it will greatly benefit your business in the long run, provided in-depth information on your business’s finances and enabling you to make better financial decisions for your company’s future growth.
Unique Aspects of E-commerce Accounting
E-commerce accounting involves much more data points with unique nuances in comparison to a traditional business model since activities are ongoing 24 hours a day.
Recording this information the way you would for traditional accounting would lead to inaccuracy, which would eventually impact your business when it comes to financial decision-making and future growth.
Here are the three main aspects you need to understand about e-commerce accounting so you can fully comprehend your cash flow and profitability:
Recording your Transactional Data
In a traditional business, the transactional data are usually found in credit card statements or the business bank account. However, the transactional details for your e-commerce business should be located at the backend of your selling platforms.
Here’s what you should look out for:
Income and other Crucial Information
Delve into the backend of your selling channels and break down the transactions when you are maintaining your records. Avoid recording what is reflected in your business bank account, as that amount is likely to be made up of 20 to 30 transactions that include sales, returns, sales tax, chargebacks and even shipping that is paid by your customers. Thus, recording this information will result in the gross inaccuracy of your profit.
Alexander has received his bank statement for January, which reflected a net deposit of HK$ 25,000. He proceeds to record this down as his profit for the month, neglecting the fact that he has yet to factor in the sales tax and shipping. He does the same thing for the subsequent few months, and this eventually affects his numbers.
Time of Transaction
Similarly, avoid recording the time of transaction shown in your bank account. This is not indicative of the actual transactional timing, which could be found in your selling platform’s backend.
On 17 January, Maximillian sold her Apple AirPods Max on Alibaba. However, Alibaba processed the payment only in February, which resulted in her bank statement reflecting this transaction on 14 February. Maximilian records 14 February as her time of the transaction, which is inaccurate. Unfortunately, the customer was unhappy with his Apple AirPods Max purchase and wanted a refund. Due to her error in recording, Maximilian was unable to locate the time of the transaction, which led to complications.
Full Comprehension of Inventory and Cost of Goods Sold (COGS)
Owning your own e-commerce business means you should pay attention to your inventory, as well as the Cost of Goods Sold (COGS). You or your bookkeeper should have a deeper understanding of this aspect of accounting, focusing on the following:
- Managing inventory and the controls around your most important assets
- Accounting for the flow of inventory
- Computing advanced COGS number for each product SKU
- Understanding bookkeeping principles for the management of inventory and COGS (you’d be surprised that many bookkeepers tend to get this aspect wrong!)
Reducing Foreign Transaction Costs
As an e-commerce business, you are likely to face foreign transaction costs regularly. Using the right tool to reduce transaction costs can help your company to profit even further.
The Complexities of E-commerce Accounting
The Challenging Process of Inventory Management
Inventory management can be a headache when it comes to keeping track. Some units of inventory could still be in production, while others could be on the way to you, or just sitting in a shopper’s shopping cart.
Whatever the case, figure out a tracking system that best works for your business model. Doing so would help in the future when your business grows and receives an influx of transactions and a number of SKUs as you foray into different countries and the marketplace.
Keep Track of Sales Tax Liability
A common mistake e-commerce business owners in Hong Kong make is not filing their profit tax return on time. While Hong Kong has a low-rate tax system, they have penalty fees in place. If you're liable for tax outside your familiar jurisdiction, consider enlisting the help of third-party services to help you manage local tax and stay on top of things. We can help with that, by the way.
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