Inventory itself is placed into your balance sheet as an asset and only subtracted from your P&L when it’s sold or becomes “dead” (unsellable). Running sales-based COGS demands accurately sorting your inventory purchases into subcategories. Sales-Based (Accrual): Recorded when inventory is soldįor purchase-based COGS, you’ll have no direct view of your real inventory balance until a year-end adjustment is made to reduce your COGS for any unsold inventory still on hand.Purchase-Based (Cash): Recorded when inventory is purchased.When you sell the inventory, it becomes a cost of goods sold (hence the name cost of goods sold and not cost of goods purchased).īecause of the complexities involved in properly tracking inventory and COGS, some brands may choose an alternative method of tracking their inventory. When you purchase inventory, it becomes an asset on your balance sheet. Whether you are recording your books on an accrual basis or a cash basis, most inventory-based businesses record the inventory and COGS component of their financials on an accrual basis for tax purposes. Value, on the other hand, leaves your business only when you sell inventory. To do that, money leaves your business in the form of lump-sum inventory purchases (i.e., the cost of inventory), which include: Let’s start with the first half of that journey - getting your products from non-existent into your business’ hands … ready to sell. In its widest sense, cost of goods sold encompasses everything you pay to get your products from non-existent into your customers’ hands. Variable: Cost of Goods Sold (COGS) Inventory Purchases vs Landed Costs For example, your rent is your rent - no matter how much space you actually use. Therefore, your costs vary.įixed costs are costs that do not change in direct proportion to sales. Variable costs are costs that change in direct proportion to your volume of sales. While all those somethings vary widely, they can be divided into two essential types: variable costs and fixed costs. Both at the same time.Įvery kind of “money in” is defined by its relationship to “money out.” Sales minus something is the pattern we followed over and over again above. As an accounting system, it’s no less real than cash. At which point, it produces value in excess of what you originally paid.Īccrual accounting reflects that value exchange in monetary terms as though it occurred on a single date. The value of that asset isn’t lost until you sell it. When you purchase inventory, your business loses money. For the sake of clarity, perhaps a better word than either accrual or incur is value. The alternative is accrual-method accounting, which records transactions on the date they’re incurred - regardless of when money is exchanged. What’s the alternative? Accrual Accounting More to the point, only businesses generating less than $25M for three years can file taxes using cash-basis accounting. Nor for any business with pending receivables or payables. On the 20th, you receive payouts from Shopify for $750K related to sales generated in December.Īt the end of the month, you have unpaid bills of $100K relating to other operating expenses - such as a marketing agency fee - and you have open B2B invoices of $250K from a wholesale channel.ĭespite its simplicity, cash basis doesn’t provide an accurate financial picture of inventory-intensive businesses like ecommerce. On December 10, you pay $400K in various operating expenses for salaries, office supplies, influencer fees, etc. Real money out? Subtract.Ī straightforward case would look something like this … In their early stages, so do most small businesses. It’s straightforward and provides a clear picture of how much money your business has at any given time. Accounting Methods: Cash Basis vs Accrual Cash-Basis AccountingĪs the name implies, cash-basis accounting records transactions when cash changes hands. Here, let’s define the two types of accounting methods and the three key types of reports. We’ll cover bookkeeping in the next section. Accounting only becomes a profit-generating mechanism when the right data is combined in the right way. That distinction matters because how you keep your books - timeliness, categorization, and reconciliation - determines what those books can tell you. In other words, accounting is the what of ecommerce finances. While “accounting” and “bookkeeping” are often used interchangeably, bookkeeping focuses on financial transactions: recording, tracking, and managing data. Accounting for Ecommerce Businesses: The Types What Is Ecommerce Accounting?Įcommerce accounting is the practice of reporting and analyzing financial data for the purpose of making profitable business decisions.
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