How to review your ecommerce Profit & Loss
Step-by-step guide to help you review the accuracy and quality of your ecommerce P&L
We’ve said it before and we’ll say it again. Really understanding your books and knowing how to read your financials is the key to your ecommerce brand's financial success.
If your online or Shopify books aren't accurate, up to date, and relevant for ecommerce, you are throwing away time and money each month on books that don't provide you the value you need and, more importantly, you are likely missing opportunities to identify and correct the weak financial links in your business.
This blog will help you understand the health and quality of your ecommerce financials. Can your P&L, cash flow, and balance sheet be used as an accurate compass to the financial health of your business? We're about to find out.
We’ve reviewed the bookkeeping of hundreds of ecommerce brands and we’ve seen it all. The good, the bad, and the ones that should be sued for negligence. We'll walk you through a real-life example and step-by-step guide on how to audit and review the accuracy of your ecommerce accounting and ecommerce bookkeeping.
What to look for when reviewing your P&L
Let's start with a real-life example. In March 2023, we were approached by a 7-fig home electronics DTC brand selling on Shopify. They were paying $499 per month for an online bookkeeping service that doesn’t specialize in ecommerce and they weren't sure if they could "trust their books." For purposes of this blog, we'll call this brand 'Sparks.'
Here is how we walked them through a review of their financials - what to look for, common errors, and the mistakes we found in their income statement.
1. Timing - How relevant and updated are your financials?
Timing is everything. If you don't have your numbers until the 15th of the following month, that's a major red flag.
The key purpose of bookkeeping is to give you the numbers you need to manage your business. If you don't have your numbers for at least 2 weeks of the month, you are left making decisions while being completely financially blind. It's the equivalent of deciding what to wear on next week's vacation based on last week's weather.
In this example, the brand founder approached us at the end of March. As you can see from the image, we reviewed their February financials.
One nonsensical reason—the March books were barely started!
Imagine telling your customer: “Your product is on its way, you’ll receive it in just 45 days.”
Sounds ridiculous, right? Yet, this seems to be the accepted norm when it comes to bookkeepers.
2. Revenue - Is it reconciled with the source of truth?
The next step when reviewing the accuracy and quality of your ecommerce bookkeeping is to see if your sales data is completely reconciled with the source of truth. In this case, the sources of truth are your sales channels and payment processors - Shopify, Amazon, Walmart, Faire, Stripe, Paypal, etc.
Your P&L should show your sales:
- Separated by sales channels so you understand the profitability of each channel
- Separated by gross sales, discounts, refunds, shipping income, and net sales
Your P&L should NOT show your sales:
- Based on your net payouts in the bank
- Combined into one total amount instead of separated by sales channels
Once we did get access to Sparks' February financials, we ran the numbers by syncing the data directly from Shopify. Unsurprisingly, there were some significant differences in their actual Shopify sales numbers, discounts, refunds, sales tax, and merchant fees.
Key lesson: always reconcile back to the source of truth.
3. COGS - Are you recording COGS when purchasing inventory or when selling inventory?
Sparks previous bookkeeping service worked only in cash basis accounting. That means the DTC brand couldn’t use accrual basis accounting, which is often a better fit for an inventory-based brand. Your goal should always be to have a real-time understanding of your financial health.
Now, using cash basis alone is not a red flag of unhealthy books. Many ecommerce brands file taxes using a cash basis method and Finaloop offers both an accrual and cash basis option for your bookkeeping.
Here is where the red flag comes in. If you have an inventory-based business, the general rule according to the IRS is that you need to track and report your COGS based on accrual rules, even if you use cash basis accounting.
Not following these tax laws can completely skew your numbers and cause major issues with the IRS.
In Spark's financials, inventory purchases were treated as COGS right away, whether or not the product was actually sold. This increases the risk of a potential IRS audit.
Read more on our blog Cash vs accrual accounting myths debunked.
4. Gross margin - Are you calculating gross margin based on ecommerce best practices?
You need to know the cost of your sales to understand your real gross margin and contribution margin. Merchant fees and shipping-out costs are part of your cost of each sale and should be included as part of your COGS, impacting your gross profit, NOT your operating expenses.
We see countless traditional bookkeepers that are not doing this since it's very specific to the ecommerce space but can lead you to miscalculate your gross margin and misprice your products.
5. Chart of accounts - Is your CoA tailored for ecommerce?
Breaking down accounts is an art form. You need to strike a perfect balance between granular details that show you where your cash is going without too many details that make your books messy and unsustainable. This is also what investors and buyers want to see.
The breakdown in Spark's previous financials is very generic and gives zero financial visibility. Looking at a blended number doesn’t help you make smarter decisions. You want your account broken down with real numbers, from today and not months ago.
For example, the previous financials include an account called 'Marketing & Advertising Expense.' This may be fine for tax purposes but gives you zero visibility into your real advertising and marketing expenses. Here is a better example of how your chart of accounts for advertising and marketing should be broken down:
6. Financing fees - Do your books accurately record your interest and financing expenses?
Despite this brand having Shopify Capital and a PayPal Credit Line out, we didn't see any financing fees or interest calculations. That creates two big problems:
- The financials are less accurate
- The brand would miss out on significant tax deductions
Make sure your bookkeeper really understands ecommerce, because the truth is that most don’t. And if you’re unsure if your bookkeeping is properly set up, hit us up to see how AI accounting and AI bookkeeping can help you! Sign up HERE to get your financials set up today.
We are a technology company providing automated end-to-end accounting service to ecommerce businesses. Our system connects to your apps, syncs all your data and reconciles your books in real-time, replacing your bookkeeper, your accounting software, and your ecomm integrations. We offer reconciled books available 24/7, tax-saving insights, and a single place for all your financial data.
The information provided on this website does not, and is not intended to, constitute legal advice. All information, content, and materials available on this site are for general informational purposes only. Readers are advised to consult with their attorney or accountant with any questions or concerns.
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