Entrepreneurs can make a great venture out of opening a dropshipping shop. Your products can be accessed 24/7, all year round, by international customers through an online shop. You can reach a large audience with drop-ship orders and maintain a small physical footprint through the World Wide Web.
While purchasing a domain name, hosting, and setting up the store are important steps, financial planning is essential to ensure your store gains traction.
After your store is set up and live online, you need to make sure that stock levels are adequate and expenses are recorded. Quickbooks has integrated solutions that can help you with all these issues.
What is bookkeeping?
Bookkeeping basically refers to the tracking of money flowing into and out of your company. Dropshipping is no different than a traditional retail shop when it comes to accounting and bookkeeping. Online retail business accounting means that you focus on inventory and cash flow while retail accounting software helps you to pick up the pieces.
Your inventory is the foundation of your retail business. Nearly everything you do depends on it. Many financial reports and documents you receive focus on inventory.
What makes retail bookkeeping unique?
The process of dropshipping bookkeeping and accounting looks very similar to other industries. You can easily understand bookkeeping if you have some accounting experience. The principles of retail bookkeeping can be understood even if you don’t have the necessary experience.
Bookkeeping basics for Dropshipping
When you set up an accounting workflow for your dropshipping store, there are many steps that you need to take. This simplified version might look something like the following:
- Decide how you want your inventory to be tracked and cost.
- Get retail accounting software
- Make templates for sales orders, invoices and receipts
- Track your inventory
- For your first month in business, create a balance sheet and income statement.
It’s important to understand the basics before you begin to do the math to calculate your revenue and expenses. Financial statements are the best place to begin.
Financial Statements That You Should Know
You must keep a clear view of your finances as a business owner. You can have a better understanding of your finances and be able to manage your business spending. This will allow you to improve and develop your profit margin. This information is presented in financial statements.
There are three main types of financial statements that are used in almost every business model, regardless of size or industry:
- Balance sheet
- Statement of income
- Statement on cash flow
Your balance sheet records your assets, liabilities, and owner equity. The assets equal the liabilities plus owners equity, otherwise known as the Accounting equation: Assets = LIabilities + OE). A balance sheet typically consists of two columns. One defines your assets, the other your liabilities.
A balance sheet is so named because both columns should be balanced and show the same total profit or loss at the time you create the sheet. A balance sheet is used to show the financial health of your company.
You list all assets of your company in one column on the balance sheet. These are your inventory, cash funds and accounts receivable (money that clients owe you and which you expect to get within the next year). Dropshipping retail is likely to have fewer physical spaces and equipment. Your greatest assets will be your inventory and cash. Your balance sheet should include investments and unpaid invoices.
You must also list your liabilities in the other column. These include debts and money owed for business reasons. An outstanding balance on a small-business loan or credit card debt from business purchases can be considered a liability.
Your income statement includes all of the money brought in over a given time period, typically a month, quarter, or year. This statement includes both operating income and non-operating. Operating income refers to any money earned through business activities. If you have a Dropshipping clothing retailer, your primary source of income is inventory sales.
Non-operating income is money that has not been directly related to your business. If you take the clothing retail store as an example, non-operating income could include equipment sales, property sales, and investment returns.
Profits from the sale of warehouses would not be counted as operating income if you started out in a warehouse and then moved to a smaller space. Same applies if your company made a profit reselling equipment such as a sewing machine, or received dividends from its investment.
Statement on Cash Flow
A cash flow statement is probably the most important document you can have as an e-commerce entrepreneur. It includes all costs, such as rent and maintenance, as well income streams, including each sale.
The cash flow statement shows not only your company’s gross revenues (how much money was made through sales), but also your net profit (how much money you had left after expenses). It also reveals whether money is being spent to support business growth or be drained by unneeded costs.
Cloud accounting software such as QuickBooks Online helps you to keep track of all these figures, because it makes the data you need for cash flow statements readily available. An accurate cash flow statement is vital, as it can help you avoid overspending and running out of stock.
Why inventory cash flow is so important for retailers
The most important aspect of retail e-commerce is maintaining an organized and cost-effective inventory. Inventory management is not just about stockpiling the items you plan to sell, but also involves keeping track of your cash flow.
Cash flow is the sum of the money that flows into and out of a company on a monthly basis, quarterly or annually. Knowing exactly how much money is flowing through your business will help you maintain a positive profit margin. Your cash flow statement will show you where you have overspent so that you can plan to reverse it.
It is important to calculate cash flow for inventory. For example, the inventory cash flow document should only list costs that are inventory-related. You will need to include the cost of purchasing inventory, but also other items like manufacturing and maintenance costs.
If you produce all the clothing you sell in-house, you might add the cost of raw materials and equipment acquisition/maintenance. You should add the cost of maintaining and operating your freezer if you have large quantities that must be kept frozen.
You must also track inventory sales and expenses, in addition to maintenance and purchase costs. You can lose inventory due to theft, loss, spoilage, damage or any other factor that makes it unsellable. Although you will do everything possible to avoid inventory loss, it is important to be ready to handle it when it happens.
You can track inventory cash flow by knowing your inventory cost and value. This will tell you how much profit you make selling your inventory.
You will need to know the number of units purchased, the cost of manufacturing each unit and the price you intend on marking each unit up when you sell them.
Inventory costing methods
There are many ways to calculate the cost of your inventory. There are many methods that can be used to calculate the cost of your inventory. However, some methods may work better depending on what you sell. These are the most popular methods for inventory costing:
- First in, first out (FIFO).
- Last in First Out (LIFO).
- Average weighted
- The retail method
The FIFO method assumes that the first items that you purchase for your inventory will also be the first to be sold. This is especially useful if you have perishable inventory (such as food products and health supplements). Imagine that you are calculating your inventory for the first quarter. You have purchased three batches: one in January and one each in February and March.
- The January inventory batch consisted of 2,000 items each at $4.
- Each item cost $6 in the February batch of 2,000 products.
- Each item cost $8 and totaled 2,000 products in the March batch.
You sold 5,000 inventory units during the quarter. This left a total of 1000 unsold. Because your March batch was the final “in”, you can assume that the 1,000 units not sold this quarter are from the March batches. Everything in the previous batches was sold first. Simply add all of the items that were sold together to get the total cost.
- (2,000 x $45) + (2,000×6) + (1,001 x $8) = $28,000
- $28,000 = Your total inventory cost for quarter one
LIFO is very similar to the LIFO method, except that you assume the most recent items will be the first to sell. This method is great for retailers who sell non-perishable items such as clothes, jewelry, or furniture.
Let’s say you bought the same quarterly units as in the previous example. You’re using LIFO this time so the 1,000 unsold units are taken out of your January batch. This is how the calculation looks now:
- (1,000 x $45) + (2,000×6) + (2,00×8) = $32,000
- Your total inventory cost for quarter one is $32,000
Neither IFRS nor CRA allow the LIFO method.
The weighted average takes the average cost for all inventory units. It does not take into account what inventory was sold first. Simply calculate the cost of all your inventory. You would first calculate the value of your entire inventory using the same example as above.
- 2,000 x 4 = $8,000
- 12,000 x $6 = $12,000
- 16,000 = 2,000 x $8 =
Add the total cost to obtain one sum. Divide that sum by your inventory’s total units.
- ($8,000 + $12,000 + $16,000), / (2,000×3) = $6
- All inventory items have an average cost of $6
You can multiply $6 by the actual number of units sold if you take $6 as your weighted average. If you sell 5,000 units out of total 6,000, your inventory cost would be:
- 5,000 x $6 = $30,000
The Retail Method
First, determine your cost to retail ratio. This is the percentage of your markup. As an example, suppose that the items you bought for $4 are sold to customers for $6.40 each. Your cost-to retail ratio is 0.6 or 60%.
Calculate how much revenue you earned from sales in the quarter. Your business sold 5,000 units which equals $30,000 according to the weighted average method. You earned $48,000 in revenue at a markup of 60%. Divide your total revenue by the markup percentage and subtract this sum from your cost calculation.
- $48,000 / 0.6% = $28,800
- Total inventory cost = $30,000
- $30,000 – $28,800 = 1,200
- Your closing inventory cost for $1,200
You can choose which method you prefer, but they all work together to make sure that your final cost figure is accurate by accurately tracking your inventory. Here is where inventory tracking techniques come in.
Inventory tracking methods
Although it is not difficult to determine the cost of your inventory, it requires a clear picture of how many units you have at any one time. Inventory tracking is the process of keeping track of your physical inventory. There are two main methods to do this: perpetual and periodic.
Periodic inventory tracking
You must conduct periodic inventory counts at regular intervals using periodic inventory tracking. A physical count is the process of counting each unit in stock and keeping track of its cost and value. You can update your inventory cashflow sheet each time you count inventory to show how much your company has spent on it.
You can choose to take inventory monthly, quarterly or annually depending on the complexity of your ecommerce business. You might find it more beneficial to do periodic inventory monthly if your business is just beginning. This will allow you to get a better picture of your overall inventory over a time period when there is more fluctuation.
Tracking of perpetual inventory
This system allows you to track your inventory. It is usually made easier by automated accounting software. The software updates your inventory count and purchase account as soon as an item is entered into your inventory storage. This allows you to always have a current inventory value.
QuickBooks Online Accountant provides inventory tracking services that automate your inventory. This method instantly updates your total sales and inventory costs every time you add or remove a product from your inventory. You can also integrate your QuickBooks account with your favourite store inventory app to make tracking a breeze.
Sales Orders, Sales Invoices, and sales Receipts
Most people have dealt with sales orders, invoices, or sales receipts. What purpose do these documents serve and what are their differences?
A sales order is a request by a customer to purchase one or more of your products. The sales order is a request for payment, but it does not automatically deduct from your inventory. This is because you have not had the opportunity to fulfill the order. In retail shops, there is very little variation in what customers order and what they get. Sales orders are quite common. Your customer fills out a sales order when they click “check out” on the website and enter their credit card information.
An invoice, unlike a sales order is a document that is used to request payment. An invoice lists the activities completed or the cost of individual components or materials, as well as the total product cost. Although invoices are less common in ecommerce, you can still use them if you make custom products.
After the order has been completed, the invoice is sent to the customer.
Customers may choose to communicate with you directly if your Dropship company produces custom furniture pieces. You might be able to work with your customer by phone, email, or text message to establish the materials, dimensions, budget, and build the furniture. An invoice may be used to show how labour and material costs were incorporated into the final cost of the product.
Invoices can include shipping costs. Invoices can be used as proof of customer requests and as receipts that allow the customer to see the pricing breakdown for all products. It is also a record of your inventory materials’ use.
A receipt is a proof of purchase that is issued after goods have been delivered. However, it is not an invoice or a sales order and does not serve as a request. Receipts simply list the services or items purchased and delivered. They also show how much the customer has paid.
A sales order or invoice can be used as the basis for a receipt in Dropshipping. To serve as a receipt, you might package your products with a duplicate of your original sales order.
QuickBooks lets you create sales receipts, orders and invoices. These can be linked with other accounts to track inventory. Quickbooks allows you to quickly and easily update your inventory tracking online when a sales order has been fulfilled. You can also set up alerts that will notify you when inventory of a particular type is low so you are aware when it is time to replenish.
Additional Reading and Resources
To run an dropshipping company that is successful, you don’t have to be an accountant. It’s worth learning the basics of bookkeeping online for retail businesses. This will help you understand the expectations and where to focus your attention while you work to get your business started. We have short videos and step by step instructions that will help you use QuickBooks.
QuickBooks will connect you to a ProAdvisor with experience in retail accounting if you are interested in taking a bookkeeping class or learning directly from pros. It can be a great strategy to speak to professionals if you are new to the business world. They will give you advice on how to balance your books and bookkeeping basics.
CPA Canada has region-specific websites that will help you locate a certified professional accountant with experience in dealing with the financial reporting standards of your region or province. QuickBooks has many helpful resources for e-commerce entrepreneurs, and CPA Canada also offers business and accounting resources for certified accountants and independent bookkeepers.