3 Key Accounting Mistakes that E-Commerce Entrepreneurs Make
3 Key Accounting Mistakes that E-Commerce Entrepreneurs Make
In contrast to all business models, eCommerce has a special accounting consideration different from all. As all of the transactions in an e-commerce business setup are made through electronic mediums, the slightest mistakes or errors can cause considerable loss.
Some of these errors might lead you to financial or legal implications that will escalate to worrying situations if left unattended. Guiding your eCommerce accountants to avoid specific accounting mistakes will help you ensure seamless operations of your business.
This article will discuss the three major accounting mistakes that eCommerce entrepreneurs make very often. It mostly happens due to a lack of knowledge and guidance on preventing them.
1. Incorrect Understanding of Revenue
Incorrectly recognizing the revenue is one of the major mistakes in accounting for eCommerce business. Most entrepreneurs and accountants tend to recognize the revenue based on records of times they were paid for the products. They do not observe the fact of when the sale was made.
In this pursuit, revenue recognition becomes false. Suppose an online sale is recorded at a month’s end. In that case, even if the money is not credited into your account, it should still be reported in the total sales or revenue generated for the month.
It is an ideal way of reporting and recording revenue, which seems compliant with the Generally Accepted Accounting Principles (GAAP). Consider your assessment and reports in terms of yearly accounting for your sales. If you miss out on considering the revenue correctly, then the sales you would make at the end of the year with big promotions might not be recorded in your reports.
As a result, you will record fewer sales, which will deteriorate your overall business metric. Moreover, you will also be violating the legal guidelines on reporting the revenue.
When eCommerce entrepreneurs consider just the deposits as revenue, it triggers another evident problem. The amount the customer deposits includes all charges, such as sale value, sales tax and shipping costs. Hence, you cannot consider the sales tax or shipping costs part of your revenue.
Moreover, as per ASC 606, you cannot recognise the revenue until you have earned it. When a customer prepays for a product, you might see the cash credited to your account, but until the sale is satisfied from your end, the amount will be deferred. Moreover, most third-party processing applications associated with your eCommerce business will take the fees from your revenue.
As a result, your total cash in the bank account will have understated revenue. Suppose you earn $500 by selling off a product from your online store, including a 2% processing fee. In that case, the net amount that will be credited to your account is $490. Hence, if you report your sales for the product as $490, you will be understating your revenue by $10.
You don’t have to make this mistake of understating revenue, as this will reduce your overall valuation if you plan to sell off your business at any time. Moreover, if your revenue records submitted to the IRS don’t match your accounting records, you might impose a compliance risk on your business.
2. Incorrect Inventory Accounting
Losing track of the inventory is one of the biggest accounting mistakes that eCommerce entrepreneurs can make. The common mistake that eCommerce accountants make in this prospect is that they don’t count on all the inventory available to your name. For an eCommerce business, inventory is always the biggest consideration.
Suppose you have deposited an amount for an inventory lot, but it is currently in transit through water transportation. So, the money you have spent on it will not be accountable as profit or loss. But it will be considered a balance sheet item for the new inventory in transit.
Moreover, this inventory in transit will not be valued until it reaches your third-party logistics. Before that, the inventory will act like a deposit for the cash you have spent. For better money management, keeping track of all inventories, whether in a warehouse or transit, should be considered and reported.
To help you better understand this, buying inventory won’t be deducted from the income statement right away. But it will be considered a current asset on the balance sheet until it is sold to the consumers. Only after the inventory is sold can the amount be moved onto the income statement under the section ‘Cost of Goods Sold’.
Another understanding of inventory accounting is that your purchase orders cannot be deducted for tax purposes, even if the money is debited from your account. Accountants mistake by deducing the entire inventory cost in a particular tax year. As a result, it might represent a lack of clarity in your tax liability, and you will be underpaying the estimates.
You must closely manage the inventory levels to ensure you can determine when you need to re-stock more specific products. Moreover, a close assessment of inventory levels, sales rate and other aspects will help you pick the items that aren’t selling much, considering which you can order less of them and more of the ones in high demand.
Use a dedicated tool to implement multi-channel inventory tracking and obtain real-time data. You have to stay on top of your inventory to ensure you don’t make basic accounting mistakes.
3. Mishandling of the Sales Tax
While running an eCommerce business, the most difficult aspect is handling sales tax correctly. It is the job of your accountant to calculate sales tax with respect to the local and state-level charges. Following that, it should be appropriately added to the transactions made by customers.
The sales tax collected on orders should be recorded as a liability and reported to the state. It should be paid on a strict schedule. The sales tax compliance for eCommerce businesses have changed over time. And now, the states have the liberty to impose sales tax on all purchases made out of state.
Most states have a specific rule that works on a threshold limit. It means that if your total sales are under a specified limit, there is no need to file or pay sales taxes to the state. Depending on your exposure to selling products, you must keep track of your state-wise revenue. It will help your eCommerce business avoid missing out on sales tax payments from various states.
Most accountants miss out on maintaining a state-wise revenue record, which ends up with miscalculations or missed payments in the end. Back taxes will result in heavy fines and penalties. Therefore, proper control must be imposed to track sales levels in every state. Moreover, the team of accountants should also keep a constant tab on changing sales tax thresholds of all states you extend your business to.
You should avoid these three most critically challenging e-commerce account handling mistakes. Your business will take a massive blow in terms of monetary losses and mismanagement of operations if you do not take the initiative to fix these flaws.
Sales tax, revenue and inventory are three major areas that constitute the seamless execution of your eCommerce business. Do not let the accounting mistakes on these parameters let you lose control over the major functions of your business.