Accounting is a painful necessity.
This is the boring side of the business. I do not like dealing with that either.
But, if you want your business to grow, you can not avoid it.
You could try to throw all your recipes in a shoebox and hand them over to a stranger.
But you will give them financial control. It means risking the success of your business.
You would give them a good deal of change to do everything for you too.
I promise you that it’s not as complex as you might fear it, though.
And you should not need an accountant for day-to-day management.
Even if you pay for help, you should always know the basics yourself.
In this way, you can understand and question what someone tells you.
After all, it’s your business at stake.
The following ten basic accounting principles will cover everything you need to know to understand your money and ask smart questions.
1. Obtain the accounting software
Do not try to assemble everything using Excel or a calculator.
Do yourself a favor and get an accounting software. Freshbooks is marketed to customers who manage e-commerce businesses.
Or if you use Shopify, there is a bunch of accounting software applications that you can get in their app store.
You do not know what you want? Test a free. Or choose one with a 30-day free trial.
The best option will depend on your business and your preferences.
If you are shopping in the App Store, be sure to choose an accounting system.
Find an app to track sales, costs, and inventory.
Avoid applications that only create invoices or simply provide reports. You want a tool that can do everything for you.
Whether you choose software via Shopify or choose something else, choose one that will be synchronized directly with your online store.
This will make life a lot easier.
2. Track your cash flow
Second step: watch your money.
If you do not have a separate bank account for your business yet, get one.
You must know that your business is making money. And the easiest way to see this is to monitor your cash flow.
If you have more coming in, then you’re probably fine, is not it?
You should also watch for when the money comes out and enters.
After all, what happens if all your bills arrive tomorrow?
It does not matter if you have $ 1 million coming next month if you can not pay your employees before that date.
Keep in mind any restraint you have on your accounts.
What payment methods do you offer to your customers? Does any of them get their hands on money?
Is there a five-day delay between when the customer pays and when the money is in your bank? You must know this when you determine when you will have money to spend.
Shopify offers a free model for tracking species. You can easily create yours in Excel.
Follow what you plan to spend each week. Track the money you plan to receive each week.
If what you need to spend is more than your current bank balance plus what happens, you know you’re about to have a problem.
Follow these tips to improve your cash flow:
- Do not pay anything sooner than necessary. If it’s due in 30 days, pay it in 30 days.
- Consider offering monthly payment plans or customer subscriptions to guarantee the entry of money.
- Keep a reserve in your professional bank account in case. & # 39;
- Do not complicate it too much. You do not need huge cash flow statements techniques.
3. Determining how to count the inventory
If you sell a service, skip this step.
The inventory is the product you sell or all the materials you use to make this product.
Do not forget to include the cost of packing or packing your product.
Determine the minimum amount of inventory that you want to have on hand and make sure you follow the inventory so you can restock it before moving on to that point.
The last thing you want is to run out of inventory and lose sales.
Why is inventory part of the basics of accounting?
The inventory is equal to the money.
That ‘s the money you spent to buy this thing. The money you will not pay until you sell your product.
And the money tied to your inventory can change while sitting in your warehouse (or store, or apartment).
If I buy 50 products at $ 100 each, and that tomorrow the price goes up to $ 150, my inventory is suddenly worth more.
But if the price drops tomorrow to $ 50, my inventory is worth less.
And beware of the “shrinkage”!
It is at this point that you suddenly have less inventory than what you are supposed to do.
You have bought 50 products. You know you sold and shipped 40.
You should have 10, is not it?
And if you have more than 8?
This is “shrinkage”.
Maybe an object was lost or stolen, or was ruined and had to be thrown away. There are many reasons why this happens.
The good news is that the shrinkage is lower when you do not have a physical retail store.
The narrowing of the warehouse is actually quite low. The typical contraction is less than 1% of your total inventory.
If you run a business from your home, it is even less likely that you will shrink.
After all, you are less likely to have someone steal an inventory if you are the only one to surround it.
It is also much harder to lose inventory in an apartment compared to a huge warehouse.
That said, the narrowing can happen to anyone.
That is why it is important to count the inventory regularly . You need to know if you have just “lost” $ 100 of product and if you take that into account.
4. Understanding the cost of your goods sold
The cost of goods sold is the expense directly related to the products you sold.
This is the inventory sold more than how much does it cost to make this inventory.
Let’s say you sell a widget. Whatever it costs for parts plus all it costs to build, it should be the cost of the goods sold for this widget.
If the parts of the widget cost $ 50, the package costs $ 10 and you paid $ 25 to someone to put it together, your cost for this widget is $ 85.
It can be a lot more confusing to know if you bought a lot of gadgets at different prices, and you pay different salaries to assemble them.
Do not complicate things.
The best way to understand this is to use a weighted average. Here is an example of a calculation of a weighted average:
($ 440 divided by 5 is $ 88.)
Anything that is directly related to your products and whose costs increase when you manufacture more products should be included in the cost of products sold.
If you pay employees for every widget that they do, include their work.
If you pay them a fixed hourly rate even if they do not do one thing that day, do not include their work in the cost of goods sold.
The retail price of an item minus the cost of this item corresponds to your “gross margin”.
This is not your profit. It tells you just how much you do on each item before adding all your other expenses.
Things can get pretty complicated here if you have different costs for different sales conditions.
For example, do you offer free shipping on all orders over $ 100?
This means that the cost of goods sold will increase each time a customer buys for more than $ 100.
This will also change for each different location you deliver.
Some sites will tell you not to include shipping in the cost of goods sold.
I do not agree. & # 39; Freight out & # 39; goes up or down with the volume you sell.
For simplicity, let your accounting system track your actual cost of goods sold. If it’s related to your ecommerce site, it should be able to do it automatically.
To predict the future cost of your goods sold, save yourself a headache and simply use an average.
If last month you sold $ 1,000 and paid $ 150 for shipping, that is 15%.
So you can assume that if next month you sell $ 2,000, you will probably pay $ 300 (or 15%) for shipping.
It will not be perfect, but it’s better than leaving the cost out of planning.
Here is a simple way to calculate your approximate average cost of goods sold, including shipping, packaging and all other e-commerce fees:
5. Calculate all other expenses
You now know your costs directly related to sales volume.
Then you have to understand how much everything else costs you.
All expenses that do not increase when you sell more or decrease when you sell less are called “fixed expenses”.
For example, if you pay a monthly rent, the amount is fixed. It will not change if you sell a widget or a million.
These costs are not part of the cost of goods sold and are not included in your gross margin.
However, they affect your profit and your cash flow.
The common fixed expenses are:
- Property tax
- Interest on Loan Payments
These expenses are considered “fixed” since you have to pay them even if you do not sell anything next month.
Do not confuse an expense with the same amount every month.
An expense like utilities could be more than a month than the next. Or maybe more in winter than in the summer.
This is always a fixed expense in accounting terms.
If an expense changes from one month to the next, you must use an average for budgeting.
6. Determine Your Breakeven Sales Needs
Budgeting and planning are important elements of running a business.
After all, you will not just want to know if you made a profit last month, you will want to know if you plan on doing one this month and the other.
The amount of your break-even sales is the amount of sales you must earn to cover all your costs.
For example, let’s say all your “fixed costs” are raising to $ 5,000 a month.
This means that you have to sell enough of your product to cover the cost of manufacturing it (including the labor) plus an additional $ 5,000 just to break even (no profit or loss).
Calculate your gross margin per unit (from the fourth base).
Next, divide your fixed costs by this amount to determine the number of units you need to sell.
If your break-even point is 5,000 and you think you can make or sell 3,000, you know you’re in trouble.
If the breakeven point is 5,000 and you think you can make and sell at least 10,000, then you know you should make money.
Remember that your fixed costs do not change easily.
For example, if you have a five-year lease, you will have trouble finding a way to reduce your rent.
This means that if your break – even point seems too high, you should first consider either increasing your prices by trying to reduce your cost of goods sold.
You could do this by charging more for shipping, using cheaper materials or finding a cheaper labor.
Here is a visual break-even point:
7. Track your pre-tax sales and profits
Now you know how many items you have to sell to break even.
Next, you need a way to track your sales.
This lets you know very early if you are going to have a problem. It will also help you manage your money.
Let’s say you understand that you have to sell 5,000 units to break even.
It is now the 15th of the month and you have only sold 1500.
If you track your sales, you can notice it. Now you have time to do something about it.
You still have two weeks left to try to attract more customers through additional digital marketing efforts.
Just make sure that if it’s paid marketing, you calculate the cost in your budget.
After all, if you spend $ 2,000 to increase your sales by $ 1,000, it’s not worth it, is not it?
You can track your sales by linking Google Analytics to your ecommerce site.
Google Analytics even has a plug-in for your e-commerce site to make it easier.
Sign in to Google Analytics and navigate to your admin settings.
Then go to your ecommerce settings.
Then enable the option “Enable Ecommerce” and “Send”.
You can learn more about Google Analytics in some of my other posts or see my video.
But back to accounting.
Now that you know about sales, cost of goods sold, and all your other “fixed” expenses, you also know your pre-tax earnings.
Keep in mind that profits do not mean that money is in hand!
Suppose you sell a service worth $ 3,000, but you offer a 3-month payment plan.
Your sales would be $ 3,000, but your bank account can only show $ 1,000.
This means that even if your accounting software indicates that you have made a profit of $ 500 after all the expenses, you will not have $ 500 more in your bank account.
If all your expenses are actually paid this month, then your bank could go red.
There are tons of accounting rules for when to recognize income.
The timing of recognizing sales and expenses can be quite complex.
Leave this for your accountant and tax time. This is not important when it comes to the day-to-day management of your business.
If you speak publicly, you will need to know the most advanced accounting reporting requirements, but they are not necessary to run your business.
8. Set up the appropriate tax rates for customers
Here is the part that most people complain about: taxes.
Taxes are inevitable, and they can become quite complicated.
If you sell a lot of products and services to a large number of people around the world, you may want to consult a professional at this stage.
Fortunately, the systems are pretty smart these days.
Your e-commerce software should take care of all of this for you.
As long as you mark a product as taxable, once your client has indicated their address, they must calculate the tax payable.
If you use Shopify, you can configure it in the tax settings:
And if you have products or customers exempt from tax, you can create exemptions directly in your online store.
Detailed instructions for Shopify exemptions can be found here.
9. Plan your tax payments
Now that you are properly set up to collect taxes, you must also make sure you are ready to pay them.
Your tax rules will depend on where you are physically located.
Wait until you have to submit as many taxes as you have collected.
This means that it is important to recognize this money as a tax and set it aside. Otherwise, it could hurt when filing!
Some online shopping services, such as Shopify, allow you to include taxes in your selling price.
This means that your product still costs $ 40.00, whether you sell it to a customer who does not pay tax or to a buyer who pays 15% tax.
The difference is that your selling price and your profits are lower each time your client is in a higher tax area.
I would not recommend using this feature.
It can be harder to plan the actual sales you expect to make.
This can also help you lose sight of the amount of profits you have collected and the amount of taxes you have collected (which you will then have to pay).
If you want to include the tax in your prices, make sure you can generate a tax return.
This should tell you easily how much you have collected in taxes, so you can always identify it and set it aside.
For Shopify tax reports, go to Reports and then Finance.
Then click on “Taxes”, and that will take you to the detailed report:
It’s a good idea to set aside all taxes that you will have to pay so that they are not lost in your bank account or included in your cash flow.
Consider opening a separate account only for taxes.
10. Understand your record
We have now covered everything on your income statement, as well as cash flow.
The last thing to cover is the balance sheet.
This is what helps you track the long-term health of your business to see overall how your business behaves.
A statement of operations is a snapshot. A balance sheet is the largest image.
The balance sheet is composed of assets, liabilities and equity.
Goods are things that you value, such as money in the bank.
Debts are debts or payments that you owe.
Equity is the difference between the two.
Let’s say your car is worth $ 50,000 and you still have $ 30,000.
This means that your assets are $ 50,000, your liabilities are $ 30,000 and your net worth is $ 20,000.
If you sold the car today, you would get $ 50,000 in cash. Then you have to repay the $ 30,000 debt you owe, and you have $ 20,000 left in your pocket.
This means that you have equity and that if you were to get rid of the car today, you would make money.
Here’s how you want the balance sheet of your business to look.
Here is a more common scenario:
Your car was worth $ 50,000 when you bought it. You have taken out a $ 50,000 loan to buy it.
As soon as you get rid of it, it has lost value and is worth $ 40,000. This is depreciation, which means that things decrease in value as they get older.
If you have to sell it now, you will sell it for $ 40,000 and pay back $ 40,000 of debt.
You will be left without a car and will still owe $ 10,000 in debt.
It is a “negative equity”. It means that you owe more than what you own.
This is a bad place to be.
If your business is in this state, it means you are losing money.
If your income statement gives the impression that you are making a profit, but your balance sheet shows a different story, you are missing something in your expenses.
Things like interest payments on loans are easy to miss.
If you have a high interest loan that increases your liability, it can easily kill your profits without you even knowing it.
That’s why the review is a good second look to make sure you do not miss anything.
A simple check to make sure your balance sheet is accurate is to remind you that assets = liabilities + equity.
I have now covered all the basics of accounting that you should follow on a day-to-day and monthly basis.
Start with basic accounting software. This will make your life a lot simpler.
Next, remember that “money is king” and keep an eye on your cash. You should handle this on a weekly basis unless you have a large accumulated cash reserve.
Then you have to understand your sales, your expenses and your profits. This is your income statement and lets you know if you are making money every week, month or year.
Do not forget to forecast taxes. Set up your e-commerce site to collect them if you need them. Put money aside to pay when you need it.
Finally, build your balance sheet. Or let your accounting software do it for you.
This will let you know how healthy your business is in the long run. This is an easy way to find out if you have too much debt.
There are many additional accounting rules and tips that can help you save money at tax time.
There are also reporting options that should be considered if you are trying to get investors or a loan for expansion.
But to run your business, do not be fooled by complicated rules. It will just distract you from your critical work of running your business.
An accountant can help you with anything beyond the basics if you need it.
What software do you currently use to manage your accounting needs?
About the author: Neil Patel is the co-founder of Neil Patel Digital.