How profitable is your business…really?
As a busy e-commerce founder, it’s easy to focus on sales and marketing while leaving the numbers to sort themselves out.
But what if a simple oversight in your accounting is causing you to overpay agencies or misunderstand your true profitability?
That’s exactly what happened to Caroline, and her story could save you from making the same costly mistake.
The Background
Caroline runs a thriving online store selling eco-friendly home goods. Business was booming, and she decided to ramp up her advertising efforts. She hired an ads agency, offering them incentives based on the profitability of her ad campaigns. Everything seemed to be going well—sales were up, and profits looked impressive.
But there was a hidden problem lurking in her accounting books.
The Accounting Oversight
Caroline was using accrual accounting, which is great for matching revenues with expenses in the period they occur. However, she was only accounting for the “buy cost”—the price she paid her suppliers for the products.
She overlooked the landed costs, which include:
-
Inbound Freight: The cost of shipping the products from the supplier to her warehouse.
-
Customs and Duties: Fees charged by the government for importing goods.
By ignoring these additional costs, Caroline was understating her Cost of Goods Sold (COGS) by 46%!
The Impact on Profit Calculations
Because her COGS was understated, Caroline’s gross profit appeared much higher than it actually was. This inflated profit number was then used to calculate the incentives for her ads agency. Over the last quarter, she ended up paying the agency $84,000 more than she should have.
How Gross Profit Should Be Calculated
Gross Profit = Sales Revenue – COGS
Where COGS (cost of goods sold) should include all costs to get the product to a state of being ready to sell, namely the LANDED COST:
- Buy Cost: The supplier’s price.
- Inbound Freight: Shipping costs to your warehouse.
- Customs and Duties: Import fees.
By omitting inbound freight and customs, Caroline’s COGS was missing substantial expenses, leading to an inaccurate gross profit for the last quarter. Her last purchase order shipment arrived 4 months ago and her bookkeeper did NOT add the freight and customs to the inventory balance but rather expensed it as paid. What a mess!
Need help with your accounting?
We provide Bookkeeping and Accounting services for Online Retailers, CPG Brands and eCommerce sellers that operate in the USA, Canada, UK and EU. Whether you sell on Amazon, Shopify or other channels, we can help with your bookkeeping, accounting and taxes.
The Domino Effect
This accounting mistake didn’t just affect agency fees. It had several other repercussions:
- Misguided Business Decisions: Caroline invested in products and marketing strategies based on inflated profit margins.
- Cash Flow Issues: Overestimating profits can lead to overspending and potential cash shortages.
- Tax Implications: Incorrect profit reporting can result in tax complications down the line.
How Caroline Fixed the Problem
Realizing something was off, Caroline consulted with CronosNow who specializes in e-commerce. Here’s how the problem was fixed::
- Recalculated COGS: We included all landed costs—buy cost, inbound freight, and customs—in her COGS calculations.
- Adjusted Financial Statements: We updated her financial records to reflect the true landed cost based COGS and profit figures.
- Renegotiated Agency Terms: Caroline then discussed the oversight with her ads agency and renegotiated the incentive structure based on accurate numbers.
- Implemented Better Accounting Practices: We set up systems to ensure all costs are accounted for in the correct periods.
- Setup a process for recording inventory: We helped to setup a proper process for recording inventory at landed cost and processed the related COGS using these updated numbers. We then implemented a tool called SellerVue (www.sellervue.com) along with a2xaccounting to drive an accurate COGS and gross profit figure.
What You Can Learn from Caroline
1. Understand Landed Costs
Landed costs are all the expenses involved in getting your product from the supplier to your warehouse. This includes:
- Product Cost: The price paid to the supplier.
- Shipping Costs: Fees for transporting the goods.
- Import Fees: Customs duties and taxes.
- Insurance: Protection against loss or damage during transit.
2. Use Accrual Accounting Properly
Accrual accounting matches revenues with the expenses incurred to generate them within the same period. This gives a more accurate picture of profitability.
Ideally a full inventory system or even ERP is used to drive these numbers, but for most ecom sellers the a2xaccounting or linkmybooks tools will give you a more than accurate enough COGS figure.
3. Regularly Review Financial Statements
Periodic reviews can help catch discrepancies early. Look at your profit and loss statements, balance sheets, and cash flow statements regularly.
Most importantly, there is an easy hack that any business user can do
- Export your income statement (also called profit and loss statement) to a spreadsheet showing the last 12 months;
- Calculate the Gross Profit percentage as gross profit divided by net revenue.
- This GP% should be very stable over time, if this is not the case you probably have a landed cost problem!
4. Consult Professionals
Don’t hesitate to seek advice from accounting professionals who understand the nuances of e-commerce.
Tips to Avoid Caroline’s Mistake
- Automate Accounting Processes: Use accounting software (a2xaccounting or linkmybooks along with sellervue is an ideal solution) that can track and allocate landed costs automatically.
- Educate Your Team: Ensure that anyone involved in financial decisions understands the importance of accurate COGS calculations.
- Monitor KPIs Closely: Keep an eye on gross profit margins and investigate any unusual fluctuations.
- Communicate with Agencies: Make sure external partners are working with accurate data.
Conclusion
Caroline’s story is a cautionary tale for all e-commerce founders. Ignoring landed costs can significantly distort your understanding of profitability, leading to costly mistakes like overpaying agencies or making poor investment decisions.
By taking the time to properly account for all expenses, you can ensure that your profit calculations are accurate. This not only helps in making informed business decisions but also safeguards your hard-earned money.
Are you confident that your profits are calculated correctly?
Need help with your accounting?
We provide Bookkeeping and Accounting services for Online Retailers, CPG Brands and eCommerce sellers that operate in the USA, Canada, UK and EU. Whether you sell on Amazon, Shopify or other channels, we can help with your bookkeeping, accounting and taxes.