I remember my very first ecommerce client from about a decade ago. My (then) partner and I had purchased a tax practice with hundreds of clients, and just one of them was an online business.
When I first encountered the income statement prepared from the prior year, it looked something like this:
And the balance sheet looked something like this:
Now, I don’t know if you know much about accounting, but trust me when I say, this ain’t it.
The problem was that even though the previous accountants may have understood accounting, they had no clue whatsoever about how to handle the accounting for an online business.
You see, there were these mysterious transactions coming in and going out of the checking account from something called “PayPal.” When the client told them that the money coming in from PayPal was payment for their services, they just coded all incoming PayPal transactions there. And when they asked about money going out, the client told them it was for expenses for the business. Those, along with random bank expenses to “Google” and others all went to Internet/Web Expenses. Why? Because, you know, the payments were all made electronically.
I knew there was a gap here, and so I began my initial foray into the wonderful world of ecommerce accounting.
What was missing?
Financials exist so business owners, lenders, and investors understand the activities of a business. They are fundamentally (and most importantly, in my opinion) used to assess the health of the business and to take actions that will make the business better. When the owner is provided with something that is no more than simply “your cash went up by $35,000” during the year – something they could’ve known by looking at their bank balance – that is a waste of everyone’s time and effort.
The following is information that would’ve been more helpful to the client in running his business.
PayPal is like a bank account. It often throws accountants because PayPal isn’t a traditional institution, but that doesn’t matter. It should be treated like a bank account. Period.
Deposits go in, and money can be spent. Transfers to other bank accounts can be made. And if the account becomes overdrawn… oh wait, it can’t be overdrawn. Why? Because PayPal requires the account be linked to a bank account and credit card in case there aren’t enough funds there.
So in the case of our friendly online seller above, the ONLY activity that the company was recording was things that hit the actual checking account. There literally could’ve been another $100,000 of revenue sitting in PayPal that had not been transferred out to the company’s main bank account. And/or there literally could’ve been another $50,000 of expenses paid out of PayPal that was never accounted for.
Umm… that’s a problem. Imagine ignoring your most heavily used bank account when preparing your financial statements and tax returns. Yeah, that’s what happened.
The other problem is that PayPal is ALSO a merchant processor. That means that when PayPal is used as a way of collecting revenue from customers, they charge a fee for that service (usually 1.9% to 3% of revenue).
Because the accountant didn’t look at the details of what was going on in the PayPal account, and frankly, ignored the PayPal account completely, she easily could’ve massively understated revenue, merchant account fees, and expenses. It happens all the time.
Web / Internet Expenses
This is still something that I see all the time when new clients join our firm. In today’s world of SaaS tools, there is an app for everything. But just because the software lives in the cloud doesn’t mean that it should be coded as a web expense (or software or dues or whatever).
Ecommerce businesses need to understand how they are spending their money. If they heavily rely on cloud tools to get there (for everything from marketing to customer support to accounting to outside services), you can’t just lump all those expenses into one garbage “Web / Internet Expenses” account. I mean, c’mon… that tells them nothing.
It’s much more important to break out the information by function than form. Put the advertising into advertising and the accounting into accounting so the business owner has a truer sense of how she’s spending her money.
Kicking It Up a Notch
Since then, Scott and I have built up Catching Clouds and have developed a niche in ecommerce accounting.
It’s nearly ten years later, and hundreds of thousands of sellers have flooded the internet looking for the opportunity to profitably sell their wares online. Shopify, Amazon, and BigCommerce make it simple to put up a store and start selling in days, if not minutes.
Now people aren’t just selling in one place, they are selling through multiple channels, trying their hand at Amazon in the US as well as internationally, Shopify, eBay, Etsy, AND (not or) many, many others.
And people aren’t just selling services via PayPal anymore. It seems so easy now to deal with the problems of the tiny one-channel sellers of services. Now daily, we are juggling companies with the integrations of 13+ shopping carts, cloud inventory, and their promotion of multiple brands along with the sales tax challenges that follow them.
Trust me when I say this isn’t for the faint of heart. Nor is it for accountants who fundamentally don’t understand the ecommerce world.