Ten episodes ago, I talked about some of the math involved in running an ecommerce business. Episode 250 ended up being one of our most impactful episodes to date.
So I thought it would be a good idea to do a deep dive on all the essentials of ecommerce accounting. To do this effectively, I needed to have an expert on board to break down all these things with me.
Luckily, I sat next to Scott Scharf and his wife at a dinner during this year's Ecommerce Fuel Live and he agreed to come on the show.
A Little Bit about Scott
Scott Scharf is the co-founder of Catching Clouds, an accounting services company that caters specifically to online businesses. Through the company, he’s worked with ecommerce entrepreneurs for nearly eight years, helping them stay on track financially.
What We Covered
In this episode, Scott and I go full Ecommerce Accounting 101. Here are some of the basic concepts and terminologies discussed.
- The most important function of accounting is to have financials you can look at on a daily or monthly basis that will tell you how your business is doing.
- Profit & Loss Statement (P&L) – all the components that make up your top-line revenue; also called an income statement. An example would be Amazon sales.
- Cost to Goods Sold (COGS) – shows how much it costs to create, ship, and sell a product/widget. Shipping cost would be included here.
- Subtracting COGS from P&L would give you the Gross Profit.
- Subtracting your operation expenses (e.g. payroll) from Gross Profit would give you your Net Profit.
- Balance Sheet – a report of the company’s assets (e.g. inventory, money in the bank) and liabilities (e.g. business loans).
Listen to the entire podcast to get a grasp of all these accounting basics so can make better sense of your financials.
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Full Audio Transcript
Intro: Hey guys, I'm doing a special pre introduction of the podcast today to tell you about a webinar that we're doing tomorrow. So if you are listening to this on the day that this comes out, EcomCrew.com/webinar. It's a free webinar. We're going to be going over email marketing, EcomCrew.com/webinar, free webinar. There's tons of golden nuggets in this thing. As you know when we do free webinars, we don't just do a sales pitch. It's all a bunch of meat and potatoes. It's about email marketing. If you're listening to this late, you can go over to EcomCrew.com/webinar and still get the replay. So again, go over there EcomCrew.com/webinar.
Thanks for listening to my little pre introduction for the podcast and now on with the actual introduction to the podcast. This is Mike and welcome to episode number 260 of the EcomCrew Podcast. So glad to have you guys along with us today. So this episode actually is kind of a part two in a way that wasn't designed to be a part two at all when I did it. But back on episode 250, which wasn't that long ago, I recorded an episode about knowing your numbers in e-commerce. And I was hoping that would help even just one person that was kind of my target when I recorded the episode.
And that episode has gotten more comments, more emails, more stopping me in the halls at conferences and things where I just came from a conference than anything else that we've ever done in e-commerce. It's already after just a few weeks, our number one most downloaded episode. So something rang a chord there with people and I'm glad that it definitely helped. So to help even more with this episode, I am bringing on an expert that knows way more than I do about this stuff, Scott Scharf from Catching Clouds.
And we're going to go through how to set up e-commerce accounting, basically e-commerce accounting 101. Even if you think you know what you're doing in e-commerce accounting, I still encourage you to listen to this; just you might pick up a tidbit or two. It's really important, obviously again, to know your numbers. If you haven't listened to episode number 250, I encourage you to go back and do that. Again, this episode got a lot of comments. And if you have any questions about this, you can go to EcomCrew.com/260 to get to the show notes for this episode, and leave a comment and Scott will come in and answer. He's going to be monitoring this thread.
One other thing I do want to mention is that Premium, EcomCrew Premium is coming on June 26 in just a couple of days, EcomCrew.com/premium if you're interested in that. That is all of the courses that we've done so far and all the ones that we’ll release in the future are a part of EcomCrew Premium, twice monthly webinars, unlimited emails to Dave and I, also our private Facebook group. And our newest course is definitely a notch above all the others. We put a lot of effort into this.
There's more content for this course than any one that we've done in the past, and it's all about email marketing. Email marketing was about 50% of ColorIt’s revenue came through email marketing, so it's something that we know quite a bit about. And it helped us build a high seven figure brand, and to have a seven figure exit probably more importantly than anything earlier this year. So go check that out at EcomCrew.com/premium. And without further ado, let's hop into this episode with Scott and start talking about e-commerce accounting.
Mike: Hey Scott, welcome to the EcomCrew Podcast.
Scott: Thank you. I'm happy to be here.
Mike: Yeah, it's great to have you on. So just for the people that don't know who you are, this is a Scott from Catching Clouds. I met Scott originally in person at an ECF event. We were both speaking and we sat next to each other at dinner. I got to meet his wife as well, because she was there, two of the nicest people you'll ever meet. And so we kind of hit off and got to chat there for a little bit. We also talked a long time ago about us potentially hiring you. I mean this was years and years ago, and we just we weren't ready at the time. It was because you guys are really good at what you do but you charge appropriately for that, which I think is fair.
I know lots of people who do use you, a couple of them are in my mastermind and they swear by you guys. So that's kind of a background on how we know each other. But today, we wanted to kind of do like a public service almost announcement or podcast kind of thing kind of just basically dubbed e-commerce accounting for dummies. And the reason this came about, episode 250 was the most commented and talked about episode that we've ever done, which was know your numbers. There's lots of people out there that this resonated with. They realize that they don't know their numbers, but they just don't know how to begin because there isn't really a college course about this as certainly is not taught in High School, that's for darn sure how to do accounting.
So we thought we'd bring on Scott, who again has dozens of clients and eight years of experience doing this with Catching Clouds to kind of walk through some just basic building blocks of how you can get your e-commerce accounting in order. So with that Scott, thank you for coming on and let's dig into it.
Scott: Sounds good. Thank you very much. Where do you want to start?
Mike: That's a good question because I'm not — I've never done any formal training myself on this. I mean, I think that the hot topics are the difference between accrual accounting and cash accounting, a balance sheet versus a profit and loss statement. How come inventory does not affect your profit and loss but just your cash position, just some basic concepts that I hear people constantly struggling with. So I think those three or four things are probably the places to start.
Scott: Okay. Yeah, we can start with that and then definitely want to cover the how, how do you set up the tools and what can you do yourself? Where do you start? The key thing if you've decided that your e-commerce business isn't a hobby, and even if it is a hobby, that you really have to do accounting as early on as possible, because an e-commerce business or hobby is generating revenue, okay. And the idea is to make more money than you're spending, and you need to know those things. And the best way to know those things is to do accounting and understand what it's for. Okay.
The first thing is accounting is for being able to do your tax returns at the end of the year, but that's not its most important function. The most important function of daily accounting or management accounting is to have financials that you know and you can look at on either a daily or a weekly, monthly basis, primarily monthly is when everything comes together and you do what's called closing the books will give you financials that you can use that will tell you how your business is doing and what's going on in your business. So one of the first things to know is there's really two key financial statements. Okay.
The first is your profit and loss statement. This is where it shows all the income, all the sales income, all the shipping income, any refunds or discounts that reduce that income right off the bat. And then your cost of goods sold. So what does it cost you to make those sales and either product or marketing or outbound shipping, and then it has all of your expenses, okay, from your internet fees to your monthly Amazon or Shopify fees, to insurance to all of those other things you spend your money on. And at the bottom of that, if you subtract your cost of goods sold and your expenses from the income you made, you find out each month did you make money.
And the other thing to keep in mind, there's a big difference between profitability in your business and actual cash flow and cash in the bank. And we can come back to that. So anything else on that, and then I'll talk — let me talk about the balance sheet and then let's get some questions.
Mike: Let me embellish just a little bit on the P&L because I want to do like a distance from like a layman's terms type of we can get two different perspectives. So a few of the things that you'll hear the profit and loss statement called as an income statement. So they're the same thing. Terms you'll hear a lot are top line income. So what that means as Scott was saying that the top of the profit and loss statement is going to be those income portions. That's why top line is your revenue, income and revenue. Again, same things people throw these terms around. So if you have your Amazon sales, your Shopify sales, your eBay sales, those are income, those are your top line income.
And then you mentioned COGS. COGS, is cost of goods sold. So it's what did you pay for the thing? And typically, you want to roll up into that, what it costs you to actually get it here and everything rolled up into those COGS. So shipping from Asia over here, and customs duties would roll into that. So that top line revenue number minus your cost of goods sold is going to be your gross profit, which is another term that gets thrown around a lot, which is really important. And your gross profit is literally just those two things. It's taking what you've earned in revenue minus your cost of goods sold.
And then as Scott said, all the things below that, all the other expenses, your payroll and your advertising costs, and those things will then be subtracted from that gross profit and then you have your net profit number. And we'll get into cash versus accrual, how that works as a function on the P&L a little bit later in this conversation. But those are some other things I want to throw out there because I hear those terms thrown around a lot.
So there's profit and loss statement is going to show you basically what you're going to pay taxes on, I guess it's probably a fair way to put it. It has nothing to do with how much money you have in the bank, which Scott was kind of alluding to, and we'll expand upon that. So stick with us here and try to keep these concepts in mind as you go into the next thing, which I assume is going to be the balance sheet.
Scott: It is. Now thank you, those are great clarifications. There are, of course, always nuances and the accountants throw other stuff in. So the next thing is the balance sheet. And this is where your assets and your liability. So your primary asset as an e-commerce business is your inventory, the inventory you have and have not sold that is in your warehouse, in your garage, out at Amazon FBA. The other assets are your cash in bank cash in the bank and your current balances on Stripe, Shopify payments, PayPal for those things that are coming through. So there are a number of assets, but the primary one for your e-commerce business is tracking your inventory.
You've converted cash into inventory, whatever widget you're selling. And that is an asset to the business while you physically own it, wherever it happens to be stored. Okay? Then you want to be able to track your liabilities, how much you owe on various credit cards, if you have an Amazon loan, if you have other loans, if you have loans to family members or others. You want to make sure that all of those liabilities are there, including a PayPal account is both like a bank but you can also spend money from it. You don't want to leave anything off, including the point if you've loaned money to the business and you're expecting to get interest back, just send an email that says hey, I've loaned the money.
And there are differences between an actual loan and paid in capital and money you put into the business that along the lines you can pull out. But the idea is to make sure you're tracking all of the assets and the liabilities for your business. One of the key things to keep in mind is if you're an e-commerce business, and you have inventory, you should always have a balance sheet. Just because you are filing your taxes on cash basis does not mean you shouldn't have a balance sheet. It is a critical tool to tell you how much money you either owe people on credit cards or loans or whatever else, or how much money you have sitting in inventory that you can hopefully turn to cash profitability wise.
So it's not just required, if you're filing accrual. If somebody says, oh, you're paying cash basis, you just need an income statement or a P&L, they're wrong. You need to be doing that additional stuff is an inventory based e-commerce business. So you as the business owner know what's going on inside your business and then filing your taxes is separate.
Mike: Yeah, I mean, very well said. Let me add a couple things. I took some notes here. First of all, one of the other liabilities you mentioned was sales tax. So that will go on your liabilities portion of the balance sheet, sales tax owed. Another common one to have under assets is undeposited funds. And depending on what business you're running and what accountant you're using, they might call this something different. But there's always a gap between when you've made the sale on Amazon and made the sale on Shopify and when you actually get the money. So you have to — you can't make money up out of thin air, everything has to — it's called double entry accounting.
So you got to account for this somewhere. And so that gap in time where the money is owed to you, it's an asset, you're waiting to get paid these undeposited funds. The money has not – Amazon is holding your money for 14 or 21 days, whatever, depending on what kind of account you have. That has to be accounted somehow and so that's the way that you would deal with that. And these are all things that end up on your balance sheet. And another thing that seems to trip people up that I just want to kind of mention, when you purchase inventory, by doing that that is not an expense. That is not a function of your P&L.
The P&L is going to show your income and your expenses as we talked about before. But the balance sheet is showing these assets. And it's very important to get this concept in your head of the different types of transactions that are happening here. So when you purchase inventory, let's say you have $1,000 in the bank, and you spend $500 to purchase inventory. The double entry accounting thing is you're removing $500 in cash from your bank account, which is an asset on your balance sheet and moving it to a different asset on your balance sheet, which is inventory. And that's all that's happened.
You still have $1,000; you have nothing to report on your P&L at that point. There is no deduction for inventory at that point, or it doesn't affect your P&L. And there are some new tax laws, which we’re not even going to cover here that allow for inventory to be treated differently.
Scott: We have a cool YouTube video on it.
Mike: Perfect, we’ll link to that in the show notes. Yeah, it's a complicated concept. But this is really important because this basic building block of e-commerce accounting is the thing I hear about the most. And that's why I just wanted to take a minute to talk about that, because it's not — the inventory only becomes an expense at the moment in time that you make a sale. And we'll kind of talk about that here as we go through. But at that point, then you get to have a double entry accounting, then when you take some money out of inventory, and then move that over to cost of goods sold. But you can't do that until that transaction has happened.
And so you can't pay your taxes on inventory. So you got to be very careful with how you treat your cash positions relative to your profit and loss positions — not positions, the profit and loss statements and what you're reporting there because you can get yourself in a cash flow crunch that can put you out of business. Even though you're making money on paper, you can get yourself in a position very quickly where you have no money to pay your bills. So anyway, that's my embellishment of the balance sheet portion.
Scott: No, that's great. And I'll add a comment about sales tax, which I should have mentioned, which is always top of mind for me. But occasionally I try to not focus on sales tax. So keep in mind, that's a liability to your business. When you collect sales tax that came through your Amazon settlement statement, or from Shopify or whatever other channel and you collect sales tax, that is a liability to your business. You hold that money both in the bank and on your balance sheet until you pay it into the state whether it's monthly or quarterly.
Now, the one nice thing if you're on Amazon, Walmart.com, eBay or Etsy seller, because of the model marketplace facilitator laws, Amazon is collecting that sales tax and remitting it. So the amount of extra cash that you need to pay attention to that's not yours in the bank will go down. That does not change and I'm not going to go into sales tax now. But it's not going to change necessarily your requirement to register and file a return even if it's zero dollars. But the idea is on your balance sheet is you want to keep track of every liability of the business, so that what's going on when you look at it, you understand whether your liabilities exceed your assets or your assets exceed your liabilities.
And there's things to be learned when you have accurate numbers on your balance sheet to learn about your business. And your balance sheet has to balance or your income statement isn't valid or it's off. It might not be off by a lot but if you don't know how to review your balance sheet to make sure everything comes into balance and that double entry accounting and everything kind of adds up, that's how it works, then your numbers are off and you can't necessarily trust your income statement. But that's how you can know if things are accurate.
Mike: Yeah, perfect, awesome. All right, so I think the next concept that we haven't talked about yet is cash accounting versus accrual accounting. So I'll let you try to tackle that one.
Scott: I mean, you covered it. But let's cover that and get that out of the place and then we'll talk about cash versus accrual.
Mike: Perfect, love it. So we're going to go into cost of goods sold.
Scott: Yeah. So now you brought it up and that's the next piece. So what we said before is you've got your top line revenue, then cost of goods sold, which will show your gross profit. So what will reduce your profitability as a business is that as you sell that inventory, and Michael mentioned this is that that's when it's done. Now, typically, cost of goods sold, it happens in real time as you're selling products, but it's really a monthly process to review all of the SKUs and quantities and the cost of those items. And then you reduce your balance sheet, you move, let's say you have a million dollars in inventory; you sold $300,000 worth of product.
At the end of the month, it's called the journal entry, you're going to move $300,000 from inventory to your income statement, your profit and loss statement, and it's going to reduce your profitability by that much. Okay, so that's just the mechanics of what's going on, it only needs to happen once a month. Now, if you're looking at your cost of goods sold per order, you want to watch your profitability per SKU, per order, how much you're making versus what Amazon's making, that is a real time function. Cost of Goods Sold is a function you should do once a month when you close the books. So that was just the point I wanted to make about that.
But for the most part, not counting a number of other topics like we're going to talk about cash versus accrual, for the most part, that's the main thing that happens between the balance sheet and the income statement from a big picture perspective.
Mike: Yeah, so the million dollar question here is how do you determine your COGS each month? Because it gets really complicated, right? I mean, you're buying inventory from a bunch of different places, you may be paying different amounts at different times for that inventory. So there's this FIFO concept, first in first out, it gets to be the point where it hurts my head, like badly hurts my head to try to keep track and tabs of all that. How does one do that?
Scott: Yeah. So it really turns out that your costs are king and being able to track and understand what your costs are, both over time, but specifically for that month. So you want to make sure you know that if you pay $30 for an item and you didn't pay shipping, any inbound shipping, so you prepaid with a credit card. And for that product to be live in your warehouse to ship, a 3PL or Amazon FBA, it costs you $30. And then you want to make sure that you're using that $30 to add up to the quantity and stock that whatever warehouse is times $30, for whatever that blue, green, whatever SKU is, so that you know that's the value of that item.
And then as much as possible, we can talk about some timing nuances. When you sell that item, you want to make sure the cost of goods sold when it's sold is $30. Okay, so how do you do that? One, you need to keep track of what your costs are. If your buy costs, you're buying items, and they pretty much cost the same every time or shipping is minimal or not even worth tracking per item, if you buy 1,000 items, you pay $5 worth of shipping, it doesn't make sense to add a few pennies to each product.
That's one key thing. But if you're buying a product, let's say from China or internationally, and the per unit cost is $2, but by the time it's live in Amazon FBA or your warehouse that costs $8 per unit, your cost, your landed cost for that item for the buy cost plus shipping plus customs and tariffs, those kind of things, you need to know that that cost for that item is $10 per unit, so that you price it properly. So you set any repricing properly, and that you’re accounting for it properly on your balance sheet when you calculate your inventory.
What that means and this is advanced thing that we do, but you need to understand, it means that you pay for your inventory out of cash, okay? You pay for shipping out of cash, because it's due when it's due. And you pay for customs; otherwise, you can't get the product out of customs. Those three invoices all need to be coded to your inventory on the balance sheet for landed cost to work properly. And everyone's like, no, I'm double counting inventory. I had my wife who's my co-founder and partner and the CPA and very smart person explain it to me six times to say no, that's exactly how the accounting works, you don't double count things.
But that's the piece people miss is they go wait. So since I calculated my landed cost is $10. But I only put the $2 cost in inventory, my inventory is always wrong, and my books are always off. That is one of the key concepts you need to understand. And that's where it can throw a lot of people off is that if you include various costs of prep fee, pack fee, the dollar per item labeling fee before it goes to Amazon, and you want that to be part of the costs you know so you never sell a product for less than you paid for it, those invoices need to be coded and they're part of your inventory.
And then when you pull up cost of goods sold at the end of the month, it includes all of those costs, and everything is accurate. And that is one of the key ways when people get going that their inventory and cost of goods sold flip and they end up with negative inventory, which isn't really possible. And that's why. So I'll stop there Mike to see if you have any other questions.
Mike: No, I mean, it's– I think well said. I think just to reiterate something that you said that I think that is most important there which was knowing your cost is king. So you need to have very good records of what you paid the manufacturer for the widget, how much you paid for shipping to get the widget across the sea, how much you paid for customs clearance, and duty and put that all in a folder and a spreadsheet, etc. to be able to establish your COGS for that item on an individual item basis so you know what your true COGS are for that item.
And as Scott was saying, and as you buy your inventory, you got to write a check or send a wire transfer to the manufacturer, well, that money on the double entry side comes out of cash, out of your bank account, and goes into the inventory account. And then when you write the check or the wire transfer for your shipping, same thing, it comes out of your checking account and goes into your inventory account. And if you pay for customers separately, that same thing happens. Now you have three different things that came out of your cash account and went into your inventory account.
So when you sell an item, you need to make sure that you're pulling out the proper amount on a per item basis on that transaction out of inventory, which is where things get a little bit complicated. So I mean, the way that we've done it up until very recently was just to keep track of that with Excel with a pivot table, because that's actually what was really just the easiest way to deal with it. And we're using some software to help with it now. But it's just really critical to make sure that you keep track of all of these different costs and your inventory balance doesn't get off.
Because if your inventory balance is getting off that means, again, because the double entry, that something else is wrong, which is going to be your cost of goods is misstated. Is it misstated on the low side or high side? It creates different problems each way. But you don't want to mistake your COGS because you're going to have an incorrect picture of your business. You're going to think that you're wildly profitable when you're not. Or you're going to think that you're losing a bunch of money when you're not, one of those two things are going to happen. And you're going to make bad decisions based off of misinformation. And this is how it happens. And it happens very quickly. So those are just some things to add to that.
Scott: No, I agree. Now, Mike, I would think everybody needs to start with a spreadsheet in a way to revalidate and update those costs. So you have a way to compare it. In my opinion, the optimal way to manage purchase orders is to use a cloud inventory tool to buy products using a cloud inventory tool and creating a purchase order and entering shipping and the per item costs and then receiving that inventory. And most of the tools when you receive them will then update the cost for those items.
Now key thing to keep in mind is that most accounting systems until you get to a higher end ERP system are going to do what's called a moving average cost. So if you bought 100 units at $100, and then you bought another 100 units at $50, your moving average cost is going to be $75. Okay and it can cause some really big swings. Not every tool does what's called first in first out where the first set of 100 items all cost $100. And then when you sell the 101st one, the cost is now $50.
And you need to be aware when these tools are showing you averages, one of the most common ways that we see that there's a difference between what's in inventory, what was pulled out of cost of goods sold. And if you look at the difference of those two numbers, is where you'll find all the nuances whether it's that moving average cost number or missing purchase orders or prepaid inventory and other topics that's there. So you want to be careful of the fact that you really do want to do the extra work of calculating both inventory and cost of goods sold and see how those compare.
Because in a lot of cases, a lot of accountants or people doing it, they just look at the inventory number, and then whatever is not an inventory, they write off to cost of goods sold, okay. And maybe at 12/31 at the end of the year, you need to do that to make sure everything works properly. But on a monthly basis, if you want to make sure you don't have inventory that's lost or stolen, or inventory that was removed or returned or whatever, all of those other nuances there, you want to make sure you look at that additional detail. And you want to know when you're using an average cost versus a FIFO cost. And if you very much care about first in first out in as much accuracy, then you need to look at a cloud inventory tool or an ERP system will get you that level of detail.
Mike: Yeah perfect. All right, I think we've covered that and beat that to death. So is it time to move on to cash and accrual?
Scott: we can talk about cash and accrual.
Mike: All right.
Scott: The first thing about cash and accrual is that it's a way that you file your income taxes. The IRS is expecting you to report the way you've done your accounting on how you file your tax return and they will have known which one it is okay, so they will look and evaluate your tax return based on that piece. If you want to switch from cash to accrual, you can't just decide. You can do it technically in your own financials and I'll talk about that in a second. But you need to have your CPA add and make a request that you want to switch from cash to accrual. It's always approved; it's not a permission thing. It's a, hey, this next tax return I'm about to file, we've used the accrual method. Okay, so that's completely separate from how you look at your financials.
So from a cash and for a better video overview of this, we have a cash versus accrual video with pop up pictures from my wife who's an actual accountant, but I will give you the basic entrepreneur answer is the whole point of using your financials is to make financial decisions. Okay? So in cash method, you're going to record your sales when you get the income. So Amazon pays almost all sellers every two weeks. Okay. And that moves every two weeks. Well guess what, our months aren't the same. It works okay in February, where that's only 28 days. But what would happen is that you randomly have things where when you get your settlement statement on the 5th of the month, it's going to record everything for the 5th of the month, and nine days into the prior month.
So when you're recording your income, which means for those of you who sell a whole bunch in December, and you get all that money in January, it looks like you made a ton of money in January and less than December, because it's when the cash is recorded. That throws numbers off. Accrual is the method that you post things in the month that they happened. You post the income for January; all the sales in January that happened in January get posted in January. It doesn't matter when you're paid for those. I mean, there's some details as to when it gets paid.
But the idea is that you would record all of that and it would spread out your income so that it's based on the month, so that all of those things stay in the month. And it makes more sense. And that's how almost all of your reports from tools like HelloProfit or Fetcher InventoryLab or whoever else are going to show them to you per month, where you think you can do it. We record for our clients, all of our clients books on accrual methods, so that you see everything posted in the appropriate month, and there are a few other nuances I'm going to talk about. And then if they file their tax returns in cash, we make a few minor adjustments in January so that you file your return in cash.
Accrual method is a much better way logically in my view, mentally, even if you're a numbers or not a numbers person is to see how your income and expenses are spread out over the year. I'll stop there. There's some things I can talk about its other expenses. But Michael, do you have anything to add on that first part?
Mike: I mean, I feel like I'm just going to reiterate here, because I think you hit all the nails on the head. It's just that it's important to run an e-commerce business, especially e-commerce business compared to other things that I've done in accrual and understand what that word means and how it affects what you're going to be looking at on your P&L. And the reason that's super important is that you want to make sure that you're attributing things, regardless of when the cash transaction part happens, that you're attributing things to the proper month. And there's all kinds of things that happen in your business as Scott was saying that might happen in a different month than what it actually belongs to.
Your payment from Amazon's a great example; they're paying you several days after the end of the month for things that happen in a previous month. You might pay for an annual subscription to a SaaS product. And that really belongs in 12 equal months just to kind of get a better feel for your business in terms of profitability on a month in month out basis. If you’re talking about inventory and COGS, if your inventory is not a function of the P&L, but you don't want to be looking at your cash balance changing, because you just spent a bunch of money on inventory and having that be the way that you're doing accounting because that has no bearing on your profit and loss whatsoever.
As we talked about before, buying inventory is just moving an asset from one place to another and you have to think of it that way. And so because an e-commerce business is relatively complex, it's important to make sure that everything is attributed to the proper month at all times. So you don't end up with swings and gyrations in your P&L that are going to make it look wildly profitable or wildly negative for a particular month that probably is just fine. It helps you normalize your costs and things across your P&L over the course of the year to the proper month, and get a much better picture of your business, and be able to make better financial decisions off of that data. And so, I mean, again, I just feel like I'm reiterating what you said there, but maybe just saying it in a slightly different way and hopefully, bringing this concept home for people.
Scott: Yeah, now that's great and a couple key points. So just as an example, if you spend $12,000 on insurance, you would pay $12,000 or whatever your payments are but you would just attribute $1,000 per month. Like you would budget look, I need to budget $12,000 for inventory or for insurance throughout the year. And it breaks it up into those pieces. The other one is good example and Michael sort of mentioned to it, but let's say you spend $50,000, you bring in multiple containers, okay. And if you posted all $50,000 of shipping to get all the product in into the month it was received, you would have lost money.
But well, let's say it takes six or nine months to sell all of that inventory. If you follow the accrual method, and you use a landed cost, that means you of course pay cash for the $50,000 in shipping or whenever it's due. But it means that those costs come out over time for all that shipping, and you end up spreading those costs appropriately. You're not cooking the books; this is the way accrual accounting is meant to be. And it's just much more insightful to take a look at. So that's kind of the interaction between those two. Do you have any other financial concepts you want to hit or do you want me to talk about kind of the practical approach to starting doing accounting and how?
Mike: Let's talk about one more thing; hopefully, we can fit this in, because I do want to talk about some of the practical approaches, cash flow management. You were just saying is a perfect example of how cash flow management is a completely separate thing from your P&L. So you used the example of the insurance bill, where you just spent 12k in cash and you need to be able to plan for that. Like I got this bill coming up, that's going to be 12k, that's going to take a huge hit to my cash. My P&L looks great. But my cash, my bank account doesn't have 12k because I wasn't planning it, or I'm having to plan for inventory purchases or shipping.
Again, at the time that you're spending this money, it has zero effect on your P&L, like you're going to look like a very healthy business if you have a profitable business. And then nothing is going to change there. So maybe just a couple of quick cash flow management tips on how to project that stuff and make sure that you're running a proper cash flow report so that you don't run out of money.
Scott: Correct. So there are some tools that are out there but that's exactly it. The idea is you can look profitable on your books. And there are so many profitable businesses that have gone out of business because their cash — poor cash management, they don't have access to capital. All e-commerce businesses have challenges with capital and enough cash because they're growing so rapidly. If you're successful at this, you can grow to the point where you've run out of cash to feed your business, because Amazon pays you every two weeks, and you've got a delay from the time you've sold it until you get the money, so how to manage it.
We've looked at a whole bunch of tools. There's various different tools that are out there that will help you project your cash, but they just don't seem to adapt enough. We tend to drop down to an Excel spreadsheet. We take the core expenses of your overhead, your rent, your warehouse, your core expenses, your payroll and everything else and map those out. So you know what your normal burn of cash is that you have to do no matter what to keep the lights on. So you know what that base burn number is. And then you look at the other things you're paying, but primarily you're looking at the rest of the money that you need to run your business on to spend.
Unfortunately, the fight is going to be between marketing spend, and how much inventory you have to spend. Of course, after that, if you haven't paid yourself as the owner as part of payroll, you want to leave whatever is left over, if there is any, for you to be able to pay yourself on a monthly basis. And I'll talk about another concept here. But the best way is for you to look at all of those, export those expenses out of your income statement, add those up, take a worst case and then look for those spikes. When did you pay for that insurance? When do you pay for some of these bigger expenses, memberships or other things that are coming on, or large expenses and map those out. And don't forget that, oh, we have to renew our website hosting, and we pay annually to get a discount, and it's eight grand, okay?
You have to know and really look at your business, and know where those expenses are and look ahead to watch the cash. And then what you have to do is estimate when your income is going to come in, so that you know that it's there. And you want to look at that independent of any capital, business loans or other things first so you know if you can run your business within the cash you have. And you just have to understand your business to that level, you're like, oh, isn't there a tool for that or whatever else. But if you haven't really dug in, that's where you really need to understand your business and look at it even more than the P&L and the balance sheet to know how you're spending cash so you know every time you get an Amazon settlement statement, you update that spreadsheet, you pull out any sales tax that was included.
And then you look to see how much money do I have left based on your own piece, if you spend 25% on marketing, 75% on inventory. And you know for sure that number is but when you project it out four, six, eight, 12 weeks, you don't run out of cash. And then you can look if you dip in if you're growing into other capital. So that's really the fundamentals that if you're not watching it really closely, you'll lose track of it, then you can automate it or tweak a few things. But without really keeping an eye and knowing what your base burn is and then the percentages, you can just run out of cash.
Mike: And one other thing to keep in mind here, if you're running an inventory based business the way that we do, which is importing from China, we have these long lead times where you're spending money to put deposits down, spending money to put final payments on inventory, we also have a cash flow projection for our inventory. And we're mapping out looking at forecasts of historical sales. And if it's a new item, planning out what we think we're going to need to do for reordering, mapping it out on a month by month basis and tallying up what we think our cash needs for inventory are going to be each month so we don't run out of cash for inventory purchases.
And this helps, as we were going through this period of 100% growth every year, to make sure that we weren't over developing too many new items, because you could again, just run yourself out of cash really quickly. The 70% deposit part comes at you hard and fast or sorry, final payments. You put a 30% deposit down and you don't have to think about it for 90 days, and all of a sudden there's like this huge number that comes and hits you over the head that you need to make your final payment, and you might not have planned your cash properly for that. And then it's going to sit in the water for 30 days or so or it’ll probably be 60 days total before you can actually sell it, even the first part of it. And then as you start selling it, you're going to order more of it.
So mapping this out on a SKU by SKU basis is really important. And the other thing I think is important from a cash flow management standpoint are the taxes. You kind of talked about this a little bit briefly, but you're going to pay your sales tax quarterly. As you get bigger, these numbers get larger. You see that cash in the bank, you don't think about oh, I owe that to California at the end of the quarter and you start spending that money for inventory purchases, or to make payroll or something as cash starts getting tight and not being in a position to pay those taxes can be really, really bad obviously. Luckily, we never got ourselves in that spot.
And the other one, which is the annual version of that is you're paying your federal taxes if you're showing a profit on paper. April was always the hardest time of the year for us because we went through this gauntlet of having to buy inventory for Christmas, for the holiday season, having to buy a resupply of inventory after that holiday season and having to deal with Chinese New Year, which is a 30 day gap and you can't get products, you have to over purchase inventory. And then like right after that, you owe your federal taxes.
And so making sure that you have all of that mapped out on a cash flow projection and you can even just do this on Excel or something simple. But making sure that you have these things figured out is going to keep you from running out of cash because cash is king. And that's why these cliché sayings exist. It's that exact example right there that can get you in a lot of trouble.
Scott: Now, what I recommend in that is if anybody is not here, and I don't know if you're familiar with just profit first business approach, and there's a book by one of our peers, one of our accounting peers called Profit First for Entrepreneurial Sellers. And the whole point is whenever you get any cash, you set aside a certain percentage for profit, and a certain percentage for taxes and other expenses and you move those into a separate bank account, both sales taxes and income taxes, so you can make those quarterly payments. And then you have to run your business in whatever is left.
Now you can start your initial profit at 1%. But this is a way even if you're growing at 100% per year, and you're deciding and choosing to put money back into the business to grow it that you're not expecting to take money or profit out over whatever timeframe. It kind of flips things around is that you take that out before you pay payroll, before you pay any other regular expenses, and set that aside. And then you have to run your business in the rest, and it is a great way to provide some discipline. You move it into another bank account and track it. We've got a couple YouTube videos on our site and then there's an excellent book.
But this is a way to do discipline in that you know when you get to the end of the year, that you know that you're going profitable, that's part of what you want to do. And it provides a structure and a discipline to run it. You're running your business leaner from a cash flow perspective but you won't have those surprises. And the fact you get to the end of the year, you worked really hard and you didn't get any profit, or you don't have cash for taxes, or you don't have cash for taxes, even if it makes it tougher to buy inventory or you know if you're tapping into that money, and you really shouldn't, or shouldn't depending on your level of discipline.
Mike: Yeah, I love it, perfect. All right, so as suspected, we're already running short on time. So I don't know how much it's going to take to go into some fundamentals of how to get this setup, but we got to kind of keep it short. I mean, maybe it's a good way to plug those courses that you have, because they can go do that on their own time or some view your YouTube videos. But yeah, we're running a little bit short on time for the rest of the podcast. So I'll leave it to you to kind of talk about some of these implementation things and try to keep it as short as we can.
Scott: Sounds good. I'm happy to do that because these are basics. Here's the deal, use a real accounting system, not a free one, either Xero.com our preference, or QuickBooks Online. Okay? If you're over 40 million, 30 million, go look at NetSuite or some other ERP system, but for everybody else, use Xero or QuickBooks Online. Okay, whichever one they're pretty much on par these days. Then you want to use a great tool like Gusto for doing your payroll, okay, they're awesome. Just use Gusto. They're phenomenal. They're on 50 states; they do benefits and everything else. That's great.
If you're an Amazon seller, the only way if you're looking at over 1,000 sellers books over the last eight years to post Amazon income and now Shopify income is a tool called A2X Accounting. You do not want to post every transaction into your accounting for any of your channels. You want to post summary information. And these are things that are covered. But this is a phenomenal tool; you're going to spend between $100 and $200 on your core business tools. You're already paying for internet and cell phone and everything else. This is extremely important to use the right tools.
There are a few add on tools that make things easier like Hubdoc, which we route all documents to Hubdoc, and they will pull in statements from Chase and Wells Fargo and everywhere else and make it easier to pull all that data. But they also help you manage all the documents that are flowing through your businesses, invoices, receipts and otherwise. Those are the core tools. You need a cloud accounting, you need payroll, you have a document management, you need something to get the data from Amazon and Shopify into your accounting. And then you'll need a cloud inventory tool to optimize your business to do purchase orders and everything else.
Those are the basics. If you want to know the specifics on how to do them, we have an accounting for Amazon course on our Academy.CatchingClouds.net and an accounting for Shopify course. We also have a supporting Facebook group for supporting both sellers and accountants to show you exactly how to configure those things to make those things happen. Connect Xero to all of your banks or QBO and it will pull in all your bank feeds. And if you're at least automating, pulling in all your expenses, your credit cards and your bank, and you're pulling in your income from your channels, you’re most of the way there and then you need to do cost of goods sold in the other functions.
But that's the core of what everybody should do. There are items beyond that and nuances but those are the fundamentals. If you've got that much down, you’re 75 to 80% of the way there. And then you can get help to review your books or learn how to close them, post Cost of Goods Sold better and things like that. And one last thing, A2X for Amazon is the most accurate tool. If you upload those accurate costs into A2X, it'll give you the value of the inventory out at Amazon FBA including sellable and unsellable inventory, and an accurate cost of goods sold. So I'll stop there. Those are the fundamentals, do those and then figure out everything else after that.
Mike: Perfect timing. It's like right where we usually like to shut off the podcast around 45 minutes max. So yeah, a lot, we obviously went over here a lot to digest. Here's my recommendation to everybody out there. If you’re — first of all, everyone should know how to do this stuff themselves in my opinion. We talked about this on our behind the scenes webinar that you helped us with earlier today as we were recording this. I think this is one of these fundamental things that you need to know how to do. You learn how to list your products on Amazon, do Facebook ads, and how to respond to customers via email and all these other different things that you're learning how to do in your business.
This is a really fundamental thing to understand so when you do subcontract this out or hire a full time employee or whatever at some point, that you can do a sanity check and make sure that they're not just blowing smoke up your rear end. I've run into several people over the last few months that hired a professional accountant or a firm to help them do their accounting, and they just did it wrong. Flat Out did it wrong, because they didn't understand e-commerce accounting specifically or they were just doing a bad job. I mean, unfortunately, lots of people out there do a bad job.
And if you don't know any better, if you're just taking the numbers at face value and accepting them as gospel, it can get you in a lot of trouble. So I would really recommend that you do that. And Academy.CatchingClouds.net can help get you there; we’ll link up to their YouTube channel as well. Scott, you had a coupon code I believe for a discount for our members, you want to throw that out real quick.
Mike: That's simple, EcomCrew. So, if you go over to Academy.CatchingClouds.net, type in the coupon code EcomCrew, it'll get you 15% off their courses. They're incredibly reasonable. I think they're 399 bucks. This is not an affiliate link or anything like that or a code, this is just Scott being nice and offering a discount to our community to thank us for having him on the podcast. We’re making enough that we don't want to, we think this is the type of thing that we need to do to help the community. Go do that.
And if you are like above a million dollars in revenue, and you just want to get this crap off your plate and have someone that's really good do it, again, they charge appropriately for being what I consider to be the best of breed out there for doing this. Contact Scott about just having them take over your whole accounting system and they will do it from soup to nuts. I know several people who use them. It's one of the few people that I have never heard anybody say a bad word about other than how much they have to pay.
And that's usually a good sign because that means that they're doing a good job and you're getting the value out of it. And that that's very, very difficult to find in anything. These are good guys. So CatchingClouds.net, if you want to just go to their website and check that out, Academy.CatchingClouds.net, if you want to look for the courses that you can do some self-teaching. Use the code EcomCrew to get 15% off. I don't know how much else to upsell you, man. I think you're awesome. Is there anything else to add?
Scott: Thank you. No other just really look, we have over 100 YouTube videos. We really try to share as much as we can make the time to generate videos to cover basic concepts, income statement, the things we've talked about to really help all sellers kind of approach these topics and kind of learn and then we cover the other business topics and a few other things to help other accountants, help sellers in anything we can do. And our vision is making e-commerce businesses better. That's not just our clients. It's really anybody we come in contact to. So Michael, thank you. And I really hope what we discussed here today helps sellers take the time to focus on their financials and be a better business. It'll help them stay in business a hell of a lot longer, and they'll sleep better.
Mike: Yeah, totally agree. I’ll end just building on that last thought, which is, this is not fun. I mean, I never — there's never been a time I'm like, man, I get to do accounting this month. I know some people that are like that. Dana is one of those people who is coming on the podcast shortly as well. She's also been on the podcast. So some people are wired that way, they love doing it. Most people hate doing this stuff, they put it off. And then you put it off for long enough that it becomes an even bigger annoyance when you have to go do it.
But if you aren't doing this stuff, in all seriousness, I would stop everything that you're doing and get this done first. This has to be like literally your number one priority in your business is knowing your numbers, period, hands down, end of story. If this is something that you're struggling with, you got to figure this out first before moving on and doing anything else in your business because the reality is, if you don't know these numbers, you're making really bad decisions in your business because data is everything. And you're statistically, like you're making a bunch of awful horrible decisions for your business, for your life, for your family, for your stability, for your sanity for everything, if you don't know this stuff.
So you got to get this worked out and make this your number one priority. If you have it worked out and you’ve been listening to this, congratulations, that's awesome. You're in the minority. Give yourself a pat on the back and go run some Facebook ads or something and something that's more fun in e-commerce. But if you are the majority and you don't have this worked out the way that you should, make it your number one priority. As Scott said so eloquently, it will help you stay in business much longer.
All right, guys, that's going to do it for this episode. Thank you so much for listening to the EcomCrew Podcast and supporting everything that we do. We really appreciate it. And until the next episode, happy selling and we'll talk to you soon. All right guys, that's going to wrap it up for this episode. Thanks again to Scott for coming on and doing this, definitely appreciate his time. If you feel like you're at a point where you can use Scott for your business, go over to Catching Clouds and check that out.
If you're not, I would still encourage you to check out his courses. They're very reasonably priced. There's no affiliate commission or anything like that from us doing this. He didn't pay to be here on the episode. He's someone that again I know, I've known and respected for a long time. I know people who use his service and this is one of these things where we're just trying to help everyone out there. And Scott is a good guy. So go check out his stuff.
And if you have any questions again, EcomCrew.com/260 for the show notes. If you want to do EcomCrew Premium, don't forget that's going to open up on the 26th. That's EcomCrew.com/premium. And we have a free webinar on June 25th that's coming out. Don't forget to go check that out, EcomCrew.com/webinar. That's lots of links this time, EcomCrew.com/webinar. All right guys, that's going to do it for this episode. Until the next one, happy selling and we'll talk to you soon.
Outro: Thanks for listening to the EcomCrew Podcast. Follow us on Facebook at Facebook.com/EcomCrew for weekly live recordings of the EcomCrew Podcast every Monday. And please, do us a favor, and leave an honest review on iTunes, it would really help us out. Again, thanks for listening, and until next week, happy selling.