Scaling and growth are two very different terms when it comes to business. They are used synonymously but scaling refers to adding revenue faster than incurring costs. Here we show how scaling eCommerce can happen with a clear accounting lens.
In this article:
- Setting up good eCommerce accounting
- Cutting costs for eCommerce stores
- Which eCommerce metrics should I track?
- Scaling dropshipping eCommerce
What Is Good Ecommerce Accounting?
Accurate bookkeeping is the foundation of any industry. Online sellers have a unique financial situation. Since all business exists virtually, it only makes sense to have a virtual accounting system. X marks the spot with cloud-based accounting software tuned to the specific needs of eCommerce.
Get a Xero plan for an intuitive accounting system. It is quick to enroll and easy to connect applications to support your business functions.
Your accounting system should be fitted with a high functioning tech stack in these areas:
- Batch Transaction Recording: Ecommerce business owners need an efficient way to organize sales. This happens by integrating various transaction feeds into one motherboard. With batch migration and reconciliations you reduce manual data entry and can leverage your ledger as a transparent view of all business transactions.
- Inventory: Managing inventory is crucial to running a successful eCommerce business. Automating unit fulfillment and linking it to early bill payment will keep your suppliers happy and orders flowing in. After all, if you don’t have inventory, you can’t make sales. Even more, you will have ample sales data to track inventory costs and discover best sellers.
- Sales and Use Tax: due to the nature of eCommerce, monitoring sales tax and where you hold nexus is always on your task list. State sales tax laws are constantly updating so understanding your tax liability will prevent you from large penalties.
Cutting Costs For Ecommerce Stores
One of the reasons owners opt for eCommerce is to minimize costs. There is a lot that goes into having a brick-and-mortar location. Taking the business online spares you from the expenses like high rent, insurance premiums, and high payroll. Even still there are areas where you can cut corners virtually to increase revenue.
Capture Discounts From Product Suppliers
When possible ask for discounts, specials, or free shipping. A good relationship with your supplier could lead to early bird bill payment discounts. Plus, vendors will run product specials throughout the year providing a good way to reduce purchase price and increase profits.
One of our clients dreads paying shipping charges and saves 15-20% a year on inventory by purchasing larger shipments. Factor in your warehouse costs because the rent to store extra products may chip away at any savings.
Negotiate To Reduce Credit Card Processing Fees
Almost all credit card processors purchase the same rates from major credit card companies. Pay attention to these bills because rates can get wild. Attempting to reduce fees by switching to a different processor probably won’t be fruitful. Talk them down! As a merchant you are a customer of the credit card processor, in other words, they do not want to lose you. Most of the time they are willing to offer discounted rates.
Trim Low Performing Inventory
Find low-performing items and get them out the door. If items in your inventory have been sitting it is costly.
For Example: inventory stored for longer than 6 months in an Amazon FBA warehouse means higher storage fees.
These costs range from warehouse expenses to higher assets added to income on taxes. Encouraging the flow of old products through strategic marketing will maximize your profits.
Accounting Metrics For Scaling Ecommerce
Accounting offers business owners an abundance of data. You may be asking which eCommerce metrics should I track? Analyzing these accounting metrics will lead to better business:
What is the Cost of Goods Sold (COGS)?
Performing COGS will help you see how much profit you are making on your products. This gives you insight into optimal SKU prices and performance. You can measure COGS with one of these three methods:
- AVCO: is a weighted average of all your units = (Total Cost of Inventory Available) / (Total Number of Inventory Available)
- FIFO: Follows the assumption that the oldest units have been sold first = (Cost of Oldest Inventory) x (Number of Units Sold)
- LIFO: Follows the assumption that the most recent units are sold first = (Cost of Newest Inventory) x (Number of Units Sold)
Knowing the price you can sell goods better prepares you for competition in the marketplace. Lowering your sale price haphazardly will not encourage loyal customers. Instead, it caters to the customers that go for the lowest price who will easily abandon you for something lower.
Gross Profit Margin
Gross profit margin is the percentage of revenue you keep after expenses. You want to monitor this to see your highest profit potential. This gives you a good window of measurement in determining profit.
Gross Profit Margin =((Revenue – Cost of Goods Sold) / Revenue) x 100
For an eCommerce business owner, your direct expenses will be COGS. To arrive at your numbers: do NOT include returns and discounts in revenue; include shipping, packaging, and manufacturing in COGS.
High-profit margins happen when COGS are low and the price is justifiable to consumers. Fluctuations in this percentage mean price changes are taking place, or there is a lack of product relevance to your audience.
Calculate Average Order Value (AOV)
Average order value measures the median value of each customer checkout. It is calculated by taking your revenue by the number of orders in the period you are measuring. We recommend monthly or at the very least every period. Note: do NOT include shipping or sales tax, you are measuring the value of the purchase only.
Average Order Value Formula
AOV = Revenue / Total Number of Orders
Increasing your average order value is a cost-effective way to increase profit margins. It is cheaper to sell to an existing customer than a new customer. You can increase average order value (AOV) with these tried-and-true methods:
- Bundles: group pairable products together and price less than they are sold individually
- Order-bumps: at checkout offer to add a low-cost product at checkout
- Cross-sells: showing like items that pique’s the customer interest
- Upsells: feature a higher-end product on the same page as the product of interest
- Urgency: “now for a limited time only” immediately creates a sense of urgency, increasing the chances of a buy
- Abandoned Cart Discounts: shoppers will return if their abandoned cart reaps a reward
- Guest Checkout: don’t force users into creating an account it only encourages a site drop-off
Transparent Customer Shipping Charges
Shipping is the highest source of cart abandonment. 28% of shoppers will abandon a cart if presented with unexpected shipping costs. It has more to do with people not being clear about the shipping price, versus your actual costs. Thus, your shipping page and prices need to be constantly monitored. Try a calculated shipping feature at the beginning of checkout to bring transparency and instill trust with customers.
Calculating Free Shipping Threshold
Randomly setting a free shipping minimum will not increase profit. Likewise, a free shipping minimum that is too high for your average order isn’t enticing. Instead, find a free shipping threshold that will still produce a profit AND encourage sales. Use the formula below:
Free Shipping Threshold = ((Proposed Minimum Cart Value – Average Order Value) x Gross Profit Margin) – Average Shipping Cost
For Example: You are proposing a minimum cart value of $35 as a free shipping threshold. Your average order value is $30, shipping costs are averaging $5, and you have a Gross Profit Margin of around 60%.
Free Shipping Threshold = (($35-$30) x .6) -$5 = $3 – $5
Free Shipping Threshold = -$2 profit per order
The proposed minimum cart value needs to be adjusted to earn a profit.
4 Tips For Scaling Drop Shipping Ecommerce
A successful drop shipper is a curator of trends. This form of online selling is ideal for those that want a hands-free approach to eCommerce, but have a passion to share fine product taste. Of course, you should be focusing on all the accounting tips above, but you have unique needs that require effort in these areas:
1. Accounts Payable/Receivable Automation
Unlike standard virtual retailers, your markups are going to be a lot higher because you are not the manufacturer. Inevitably your profit margins will be lower, so you will need to reduce costs everywhere. Minimizing payroll costs for accounting is easily done by enlisting robotic process automation (RPA) for accounts receivable and payable. Let the sales roll in and the bills roll out.
2. Monitor Sales and Use Tax
As stated earlier in the article, this is extremely important. However, for dropshipping, you will need to pay special attention to state sales tax nexus of your shippers. Just because they are not selling the goods, they are shipping goods to the destination address and they need to collect sales tax. Since your store acts as the middle (wo)man, you need to have a resale certificate showing that shipper sales tax collection is not necessary.
The Streamlined Sales Certificate available in almost half the states makes resale tax collection simple. The Multistate Tax Commission Certificate covers another grouping of states. For the states that don’t participate in these programs, you will need to get their specific resale certificate OR collect sales tax on behalf of your supplier.
3. Customer Acquisition Cost (CAC)
A good portion of costs will be related to marketing and site testing. Your site will be sharp, and your checkout should be as user-friendly as possible. That being said, understanding your customer acquisition cost (CAC), how much it costs you to acquire new customers, is a way to keep marketing expenses down.
Customer Acquisition Cost (CAC) Formula
Customer Acquisition Cost (CAC) = (Total Marketing and Sales Expenses) / Total New Customers
Dropshippers hone this number in advertising campaigns. If the costs outweigh your sales, then you’ll need to explore a better way to grow your client base.
4. Trend Analysis
Keep up with the success of each of your products. You can do this through trend analysis which studies the historical sales performance of an individual SKU. Comb through any patterns in product sales like the timing of sales, geographical location, demographics of the customers, etc. With this data, you can build a clear marketing plan to encourage more sales.
Smart Accounting Tricks To Scale Ecommerce
Accounting is based on good data. The success of your store depends on how you leverage accounting. By mining that data you can arrive at financial insights to drive your business. Scaling means you have mastered these metrics and now have the capital to diversify investments. There will always be a price that is lower than yours, there’s no getting around it. Know that, and prove to the customer why they should choose your product.