Hello and welcome to E-Commerce Accounting 101! This series of posts will give you practical advice and some pro-tips on how to manage the finances for your Amazon or other e-commerce business.
Today I want to talk about what makes e-commerce accounting unique and in some ways more challenging than other industries.
Each industry has pros and cons in terms of financial management and performance. I used to own a company in the healthcare services industry and our biggest financial challenges were collecting AR and managing margin on labor. An Amazon FBA business doesn’t have to worry about accounts receivable or direct labor expense but probably has a ton of cash sitting in inventory and may have sales tax liability in multiple states! So each industry is unique and I want to share 5 challenges that are particularly relevant for e-commerce sellers.
5 Reasons E-commerce Accounting is Challenging
1) Sales Tax Liability Can Be Confusing
Keeping up with where you owe sales tax is a nightmare for e-commerce sellers especially those who Fulfill By Amazon (FBA). Amazon has more than 90 fulfillment centers in more than 25 states! In most cases, if Amazon transfers some of your inventory into a particular state then your business all of sudden has legal nexus (presence necessitating tax-filing) meaning you are obligated to collect and remit sales tax for sales made to residents of that state.
Think about this politically for a second: If you are a lawmaker for a particular state raising taxes on your voters is almost always a non-starter but if you can find a way to collect sales tax from businesses that are headquartered outside of your state you win! And that is exactly what several states are doing right now. States are suing Amazon for access to seller lists and are using those lists to send out collection letters for back sales tax. Make sure you understand where your inventory is and develop a risk-management strategy to protect yourself.
There are also several states that will prosecute you criminally if you collect sales tax from their residents without properly filing so this is a big deal and can create some major accounting headaches.
Most traditional retailers only have to file for sales tax in the states where they have a physical location while e-commerce sellers may be managing 20-30 monthly or quarterly filings! Check out TaxJar (they are amazing) and let my team know if you need any help getting set up in a particular state. Check out this Seattle Times Article about Amazon and Sales Tax for further reading.
2) Inventory Management Is Complex
How much inventory do I have and what is it worth? When you were selling lemonade in your neighborhood as a kid this question was very easy to answer. But this isn’t so easy for Amazon 3rd party merchants especially those who also sell through multiple channels.
It can be very challenging for sellers to determine how much product is in production in China, en route, in customs, in your 3PL, in FBA, in a shopping cart or in a returns pile! And because of the matching principle espoused by GAAP that proper accounting requires the business owner to match expenses with the associated revenues it is the seller’s job to track inventory value from production through the sale.
Things get even more complicated as the number of SKUs, transactions, countries and marketplaces increase. It isn’t uncommon at all for growing sellers to have $500k sitting in inventory without really knowing where the inventory is or whether it is still sellable. Suffice it to say having a scalable, integrated and largely automated inventory management system is a must so that your financials can give you accurate data for decision making.
If a seller can’t manage inventory closely then they are forced to carry extra inventory which can create significant cash flow challenges.
3) Amazon Fees Are A Big Part Of Your Profit & Loss
Amazon charges fees on at least 3 parts of your FBA transactions:
- Sales Commission (6-20% depending on category with most being 15% and there are minimum fees for most categories)
- FBA Fees (depends of the size of the item, how long the inventory sits at a distribution center, category and other factors)
- Advertising Cost of Sales (ACOS) (could be sponsored product, banner ads, etc…)
Many successful FBA sellers purchase and price their products targeting the following breakdown:
Not all products fit neatly into this breakdown. For instance, you might choose to overcome some recent negative reviews by accepting a higher ACOS to drive velocity or you may not have to advertise nearly as much because you have generated lots of brand equity outside of Amazon or you may sell oversized products that carry higher pick and pack fees.
This scenario is over-simplified and each seller needs to generate SKU-level profitability targets and my recommendation is to be sure that each SKU has a gross margin after fees of at least 20% and the best products with IP protection are getting 30-35% gross margin. The point is to know where you are and fight to improve financial performance but without really good accounting it is challenging to manage your suite of products.
4) Transaction Volume Can Blow Up Your Accounting System
One challenge with retail is that success often means lots of small transactions with lots of data points. In a traditional brick and mortar store a good point of sale system can automatically categorize sku-level sales data and some of them will even capture CRM data for you to help you build your email list.
Amazon as a point of sale system is a completely different animal. Amazon won’t let you capture customer contact information for the purposes of selling to those customers and Amazon charges a bunch of different kinds of fees that need to be properly categorized.
So there are lots of transactions with lots of data. Most good accounting systems including Quickbooks Online and Xero really stink at handling 10,000 detailed transactions each month. The system will slow down and can’t handle that level of specificity. This means that you have to find an intelligent way to batch your transactions. You can batch daily, weekly, every other week or monthly.
Most of our customers choose to batch all transactions at the same pace that Amazon sends settlement payments. For most newer Seller Central accounts this means batching your sales and cost of goods sold every 14 days. Your QBO or Xero system can definitely handle 2 transactions per platform per month. This gives you the needed financial visibility without having so much data that you blow up your accounting system.
5) Returns Create Many Problems
Managing returns as an e-commerce seller is challenging especially if you sell on Amazon where customers can return your products without needing much justification.
Here are some Amazon returns categories:
- Sellable – The product is deemed to be good to go and is placed back in inventory. You as the seller need to be careful because sometimes Amazon misses the mark on categorizing. You don’t want Amazon to ship faulty products to customers who can then leave you negative feedback.
Many sellers choose to change the returns settings to send all returns back to their office or warehouse where an employee can inspect each item. This system works well if you have a small warehouse and if your item is fairly small or cheap but this can create a mountain of work and headache if you don’t have a clean returns management system.
- Damaged – There are several reasons why inventory could be classified as damaged. You will eat the cost of the inventory if the damage is your fault or you can submit a ticket for reimbursement if Amazon is at fault.
- Customer Damaged – An item is deemed to be customer damaged if it is opened and is therefore not considered to be in “new” condition. Some items really are damaged and some aren’t but Amazon employees don’t always understand your product well enough to correctly classify it.
- Defective – If it just doesn’t work.
- Carrier Damaged – If it is damaged in transit.
E-commerce accounting for returns presents challenges like having to decide when to write off the inventory and you have to ensure that the inventory doesn’t get expensed twice. Returns can complicate accounting for your inventory and if you aren’t careful they can make your books worthless.
The above are 5 factors that make e-commerce accounting and bookkeeping challenging for many Amazon sellers. I’ve read articles that recommended dedicating up to 25% of your time to managing the financial performance of your business. 25% may be too high but if you do not want to outsource you should plan several hours each week. Seller Accountant would love to help if you want to get the same visibility without spending all of your hours chasing numbers.
Thank you for reading my thoughts about e-commerce accounting but I’d love to hear your thoughts. What has been the hardest part of managing the finances of your e-commerce business?