If you're ready to start running a more financially organized and strategic ecommerce business, it pays (literally) to know the language. Whether it's just a refresher or your first 101 session, here are the ecommerce accounting and financial terms Shopify and ecommerce business owners should know.
Important Ecommerce Accounting Concepts
Accounts Payable vs. Accounts Receivable
AP and AR appear on your company’s balance sheet. Understanding the difference matters.
Accounts Payable: Refers to any bill your business owes. If you want to strategically manage your cash flow, having a strong understanding of accounts payable (what you owe and when) is a must.
Accounts Receivable: Refers to every outstanding payment owed to your business for products sold or services delivered. Knowing the ins and outs of accounts receivable ensures on-time payments and healthy, predictable cash flow.
Accrual vs. Cash Accounting
There are pros and cons to accrual and cash accounting. However, for any business carrying inventory (for example, an ecommerce business), most accountants will recommend accrual accounting.
The differences and benefits of each method warrant their own article, but here’s a quick breakdown.
Accrual Accounting: The accrual accounting method records income and expenses when they're billed, and not when the cash is actually received or paid.
For many businesses, actual "money in the bank" doesn't happen right away. In these cases, accrual accounting provides a more accurate picture of a business's financial health.
Cash Accounting: The cash accounting method (often simply referred to as the "cash method") records income and expenses only when payments are received or made. It's simpler, but may not reflect the true financial position of your business. Cash accounting is simple to maintain, and so is often the choice of smaller businesses that are just starting out.
Assets, Liabilities, and Equity
A business’s balance sheet will generally be divided into three major parts: assets, liabilities, and equity. These factors give a clear view of the financial health of your business.
Assets: The resources that make up your business, or, what your business owns. Assets can be:
- Tangible (property, equipment, inventory) or;
- Intangible (patents, copyrights, a company's brand)
Tangible assets are usually used to produce what you sell. Intangible assets represent value via their revenue potential — what they could sell for.
Knowing your assets gives you a better understanding of your actual business value; an important factor when seeking investment or a potential buyer.
Liabilities: This is what your business owes — your debts. Anytime you spend or borrow money, that’s a liability. A few examples of liabilities:
- Payroll owed to employees
- Taxes owed to the government
- Credit card debt
- Interest owed on loans or lines of credit
- Money received in advance for products that haven't yet been delivered (also known as deferred revenue)
Equity: What your company is actually worth. Equity is the value of your assets minus liabilities. It will generally appear on your company balance sheet.
Example:
A ecommerce business owns $100,000 worth of equipment and inventory.
But that business also owes $25,000 to the bank for a small business loan.
$100,000 (assets) - $25,000 (liabilities) =
$75,000 (equity)
More Ecommerce Accounting Definition You Should Know
Burn rate: How quickly your business spends money if you spend more than your business earns. Burn rate shows you how long before your existing cash reserves are depleted.
Chart of accounts: The list of accounts that appear in your general ledger (see below). It shows your business’s different categories of revenue, expenses, liabilities, and assets.
Cost of Goods Sold (COGS): The cost of materials and labor used to produce the physical products you sell. Note that COGS does not account for indirect costs like advertising.Let's say you sell potted plants online. The COGS would include soil, pots, the cost of the time spent planting each unit, and the cost of shipping the unit to the customer. Credit: The amount of money leaving an account.
Debit: The amount of money entering an account.
Expenses: The money your company must spend to earn revenue. Note that some expenses are tax-deductible and can be written off. Examples of expenses include:
- Payments to suppliers
- Shipping
- Software and equipment fees
- Employee wages
- Rent
Net Income: The amount of money left after subtracting expenses from total revenue. A measure of profit, net income shows how much money your business is actually making when accounting for the expenses required to run your business. Often referred to as your business's "bottom line."Revenue: The total amount of money earned by sales before subtracting expenses, COGs, or other core operations.
Other Important Financial Statements for Ecommerce Businesses
Balance Sheet: An important financial statement that shows what your business owes and owns at a set point in time (monthly, quarterly, annually, etc).
By helping you understand your assets, liabilities and equity, your balance sheet provides a clear snapshot of your business’s financial position.
Cash Flow Statement: A cash flow statement shows the changes between cash in and out over a given period. It helps you understand how well your business generates cash to pay its debt obligations and fund its operating expenses.
General Ledger: An ongoing summary of your business’s financial transactions. It lets you review every accounting transaction.
A general ledger is made up of smaller subledgers. Examples of subledgers include accounts payable and accounts receivable.
A general ledger is the “source of truth” for generating financial statements including your balance sheet and cash flow statement. Any financial statement generated by your accountant or accounting software will pull data from your general ledger.
Income Statement: Also known as a profit and loss (P&L) statement, an income statement tracks how much money your business earned and how much it spent over a specific period of time.
An income statement helps you easily track revenue, expenses, and profitability, providing insights into your business's performance.
Inventory Costs: Any expense related to the purchasing, ordering, storing, or management of a ecommerce business's inventory (or, product).Profit
Margin: The percentage of every dollar sold that a business owner "takes home" (or, "keeps") after accounting for expenses and overhead. The higher the profit margin percentage, the better!Raw Materials: the materials required to manufacture a business’s finished and sellable product. Depending on the company, a business will often keep raw materials in stock so they can be manufactured into finished goods ready for sale.
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