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E-Commerce Accounting: Why you should not use your accounting software to make decisions

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September 13, 2020

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Kalvin Mizzi

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One of the most common way I’ve seen E-commerce sellers manage operations is via their accounting software (typically Quickbooks).

When I say manage operations, I mean performing such activities as:

  • Inventory Management
  • Inventory Forecasting
  • Inputting Purchase Orders
  • Inputting Sales Orders
  • Analyzing Profitability
  • Other ERP type functions

ERP stands for Enterprise Resource Planning and refers to a software that organizations use to manage day-to-day business activities such as accounting, fulfillment, supply chain operations, etc. This software can help plan, budget, product, and report on an organization’s financial results.

Quickbooks is not an ERP. By treating performing ERP-type operations in Quickbooks, you are climbing an uphill battle that will result in frustration and heavy expenses to work around the Quickbooks ecosystem.

What should the role of Accounting Software be?

The role of accounting software should be to prepare financial statements, reconcile accounts, and pay taxes. Every other question about your business should be handled by your ERP.

Accounting software was never designed to be an ERP (The exception is ERP’s that have full accounting functionality built in). Your company will be at a competitive disadvantage by operating this way.

Gross Profit Discrepancy Problem

A common problem I hear among entrepreneurs is regarding a discrepancy between the Gross Profit figure in the ERP vs. the Gross Profit figure in the Accounting Software. When these numbers don’t sync, a company does not have confidence in the ERP numbers. If decisions are being made based on the ERP numbers, this can lead to the wrong decisions being made and overall a lack of control over the business finances.

The discrepancy usually because accounting is complicated and usually the ERP is not equipped to properly handle all the accounting nuances, resulting in issues mostly related to which months the revenue and costs belong to.

Gross Profit Discrepancy Solution

The only way to properly handle the discrepancy between an ERP and Accounting Software is to treat the Accounting Software as a subsystem of the ERP when it comes to any top line transactions. By top line, I mean all transactions affecting gross profit (not necessarily those including overhead).

Let’s look at what makes up the typical top line chart of accounts for e-commerce sellers:

  • Revenue
    • Sales
    • Refunds, Returns and Allowances
    • Other Revenue
  • Cost of Sales
    • Cost of Goods Sold
    • Outbound Shipping
    • Merchant Account Fees
    • Marketplace Fees
    • Storage Fees
    • Customs Fees
    • Inbound Shipping
    • Other Variable Costs attributable to Products

Essentially top line figures include all revenue and all variable costs. You can read my earlier post on Product Profitability: True Profit vs. Gross Profit to get an idea of all the “overhead” costs that many sellers typically classify as Overhead that can be attributed directly or on a prorated basis to products, and hence could appear as top line. In order to make the best decisions, you want as many expenses to appear top line as possible.

In order for the Accounting Software to be treated as a subsystem of the ERP, the ERP must be capable of:

Data Entry:

  • Inputting all Sales Orders/Invoices and Purchase Orders/Invoices
  • Generating the necessary manual journal entries that affect inventory balances
  • Inputting costs that can be attributable to products

Synchronization:

  • Be able to integrate with the Accounting Software in order to push Sales Invoices, Purchase Invoices and Journal Entries

If this is done, the role of the Accounting Software would simply be to:

  • Reconcile transactions against bank statement lines
  • Perform coding for expenses without transactions from the ERP such as “Rent” and “Payroll” (not top line expenses)
  • Review Macro Level financials for the business and calculate Net Profit
  • Review Financial Statements for tax preparation

This makes the accounting process a whole lot easier and the decision making process (done in the ERP) much more powerful.

ERP and Automated Data Entry

One of the big advantages that should occur with a well designed ERP is to automate as much of the data entry as possible, something that is very challenging when using just an Accounting Software.

A well-designed ERP should:

  • Import Sales Orders automatically, either via a Marketplace Integration (Amazon/eBay/Walmart), Shopping Cart Integration (Shopify/Woocommerce), or B2B Portal for Wholesale Customers (Point of Sale / Walk In / Phone Orders would still need to be inputted manually for those customers not willing to use the portal)
  • Generate Purchase Orders automatically or within a few clicks based on a robust inventory forecasting model
  • Automatically queue up the journal entries that may occur from inventory operations caused by Inventory Fulfillment, Inventory Receipts, Inventory Adjustments, Changes in Inventory Valuation, etc.)
  • Automatically create Customer records from imported Sales Orders which can then be synced with the Accounting Software

More advanced functionality an ERP may have would be:

  • Ability to input variable costs from 3rd party sources and have a rules-based automated allocation to the appropriate products, or a well-designed user interface for quick product allocation.
    • Example #1: Integration with FedEx to download invoices and automatically match each invoice to the fulfillment based on the reference from FedEx, then prorate to each product in that fulfillment based on weight.
    • Example #2: Have a generic CSV upload user interface that lets you take a CSV invoice from a 3rd party, upload it to the ERP, then either perform automated matching of each line item to a ERP entity such as a Sales Order (which could then be allocated prorata based on cost) or have a manual matching of the line item to an ERP entity (Sales Order/Purchase Order/Warehouse Transfer prorated or Product direct).
    • Example #3: Download Amazon storage fees (which contain reference to an FNSKU), use the FNSKU to match the line items to the product.
  • Aside from variable costs being allocated properly to the products that they apply to, have the ability to set the appropriate Nominal Code (From the Chart of Accounts) so that the expense can easily sync to the Accounting Software
  • Ability to access the ERP API so that a custom pull from the 3rd party and push to the ERP could be made to send variable cost data to the ERP in the case where an integration is not available.
  • Ability to manually input a variable cost in case an integration is not available and the 3rd party does not have an open API.

The Big Picture

If the information flow described in this blog is followed, what will result is:

  • Gross Profit in ERP = Gross Profit in Accounting Software
  • Can use ERP to:
    • Automate as much data entry as possible
    • Drill down as much as needed to segment profitability
      • Profitability by Brand
      • Profitability by Marketplace
      • Profitability by Category
      • Profitability by Custom Attribute
    • Analyze True Profitability of your Products (See Product Profitability: True Profit vs. Gross Profit) and decide which ones to discontinue and which ones to invest more in
    • Decide where to place a limited amount of capital for best return based on ROI: (See IRR (Internal Rate of Return): The True Profitability Test)
    • Forecast Inventory to minimize stock outs and maximize cash flow
    • See alerts when low margin or unprofitable Sales Orders happen
    • Endless possibilities of running your business based on metrics, in the most automated way possible

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Kalvin Mizzi

Online Seller, Finance Geek, Developer

Kalvin Mizzi has over 20 years experience in the E-commerce industry.  He holds an Economics degree from University of Toronto, where he graduated with Honors, and is a self-taught programmer and entrepreneur.

Kalvin started his career in the real estate development industry, raising equity/debt, financial modeling, and sales/brokerage.

He is passionate about systems and helping other E-commerce sellers.

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