Bookkeeping Basics for Beginners for Online Sellers
Bookkeeping Basics for Beginners for Online Sellers
One of the areas that most beginning online sellers know little or nothing about is how to keep the books for their new online sales venture. Uncle Sam wants his portion of your profits, and it is probably most common for sellers to file a Schedule C and SE along with their annual 1040 tax return with the IRS. Some people find it easier to hire an accountant to handle these things for them - they put the receipts and printouts in a shoebox and hand it off to them each January to turn into a meaningful report about if you made money or lost money. But don't you really want to know if you're making money during the year, so if you're NOT, you can work on changing that?
For small sellers just starting out, you can probably do this yourself and save a little bit of money if you have just a few simple guidelines in mind. If you took a bookkeeping or accounting course in high school or college, you're ahead of the game, but just in case, I'm going to discuss a few basic accounting concepts to give us a framework for my lens.
I'm not a tax accountant, but I have been an accountant at a non-profit firm since 1999, and earned my Bachelor's Degree in Business Administration with an emphasis in Accounting, so I've got the background to help you get started.
If you have Microsoft Excel, you can use spreadsheets to keep track of your records and help prevent mathmatical errors. If you don't have Microsoft Excel or another kind of spreadsheet program available, you can purchase ledger books at most office supply stores to record your entries in. You would want two-column and three-column ledger books. These have columns for Date, Description, and then two columns usually on the right side of the page, one for Debits and one for Credits. You would use one sheet of the two-column ledger pages to create Journal Entries, and then have a separate page using the three-column ledger pages for each Account, where you post the Journal Entries - first column for debits, second column for credits, third column for the running balance.
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There are two types of Accounting - Here is a summary of both
and how to decide which you would prefer to use to handle the accounting for your business.
- Cash Accounting - Under a Cash based system of accounting, the timing of transactions is based on when cash comes in or cash goes out. So for example, a sale would be recorded when it is paid for, not when the buyer clicks Buy It Now in your store. For expenses, it would be when the check is written, or paid. One major important thing to remember when running a business under a Cash Accounting system is you do NOT carry an Inventory. Items are expensed as purchases when you buy them.
- Accrual Accounting - Under an Accrual based system of accounting, the timing of transactions is based on when the underlying transaction occurred. So if a buyer pushed the BIN button on July 23rd, the sale would be recorded in July, regardless of whether they paid in July or August. Your ebay fees for July would be recorded as expense in July even if you didn't pay for them until August. With Accrual Accounting, you maintain an Inventory of your in-stock items, and have an expense called Cost of Goods Sold that moves items from Inventory to Cost of Goods Sold as sales occur. Items are put into Inventory at the time of purchase. This is the type of accounting I use for my business, and if you carry an inventory of items, I would recommend you use it as well.
Debits vs Credits - What are these terms, and how do we use them in accounting?
You will see the terms Debits and Credits a lot, and they're important as you decide how to record transactions in your business. Its easy to think of Debits as positive numbers, and Credits as negative numbers - but its not as easy as that.
- Debit - Debits will generally increase Asset Accounts and Expense Accounts, and will decrease Liability Accounts, Equity Accounts, and Revenue Accounts.
- Credit - Credits will generally increase Liability Accounts, Equity Accounts, and Revenue Accounts, and will decrease Asset Accounts and Expense Accounts.
- You'll be able to understand this concept a little better when you look at the examples I've provided below.
OK, so how do you classify accounts?
This is easier than you think - just take it one step at a time.
The Balance Sheet will have all of your Asset, Liability, and Equity Accounts. The Mathematical equation to Balance the Balance Sheet is that Total Assets equals Total Liabilities plus Total Equity.
Asset Accounts would include things like cash accounts, investments, inventory, accounts receivable from customers, and prepaid expenses. One example of Prepaid Expenses: if you pay for your Webhosting Service one year in advance, you can expense it 1/12th each month during that year, and carry the remaining balance in a prepaid expense account on the balance sheet. Assets represents the things your business owns or that other people owe to you. Assets generally have Debit Balances.
Liability Accounts would include accounts payable to vendors or notes payable if you have a loan to fund your business. These represents amounts you owe to other people. Liabilities generally have Credit Balances.
Equity accounts represents the Owner's Equity - or the net amount of money you've invested or earned through your business activities. Equity (hopefully) has a Credit Balance.
The Income Statement contains the Revenue and Expense accounts. Revenues minus Expenses is your Net Income. If Expenses are higher than Revenues, then it is your Net Loss. Let's hope for none of that!
Revenue accounts would be your income accounts - which would include sales to customers, S/H fees charged to customers, interest income earned on investments, Squidoo income, affiliate income, and other items where you are being paid money. Revenue accounts generally have Credit balances.
Expense accounts would be for your expenses - which would include sales fees to venues you sell on like eBay, payment processing fees to Paypal, webhosting fees, postage paid to USPS, mailing supplies for boxes and bubble mailers, and Cost Of Goods Sold, which is how much it cost you to acquire each widget that you sell. Expense accounts generally have Debit Balances.
A Chart of Accounts
What it means and how to create one
This can be as simple or as complex as you feel comfortable making it out to be. The Chart of Accounts is the list of accounts that you'll use to track the activity within your business. Accounts are classified as Assets, Liabilities, Equity, Revenues, or Expenses. You can create your own numbering system for keeping accounts organized. A very simple Chart of Accounts would be the following:
200 Accounts Receivable
300 Inventory On Hand
700 Accounts Payable
900 Retained Earnings
1000 Sales Revenues
1100 Shipping & Handling Fee Revenues
1200 Interest Income
1300 Other Income
2000 Sales Fees
2100 Payment Processing Fees
2300 Mailing Supplies
2400 Cost of Goods Sold
As you record entries into these accounts, their balances will increase or decrease. Each month, you would add up your total REVENUES, subtract the total EXPENSES, and that net amount would increase or decrease your RETAINED EARNINGS. At the end of each month, your TOTAL ASSETS will be equal to your TOTAL LIABILITIES plus your TOTAL EQUITY.
Want something more advanced?
I break my Sales Revenues down by venue, so I can measure my sales by venue easily. You can do this by creating separate accounts. For example:
1000 Sales Revenues - eBay
1005 Sales Revenues - Website
1010 Sales Revenues - Etsy
You can do the same thing with Shipping & Handling fee revenues.
You can do additional analysis of your business once you are keeping good records. For example, are you charging enough in shipping & handling? You can easily see this by taking your total Shipping & Handling Revenues and subtract the Postage and Mailing Supplies expenses. If it's a negative number, then you are losing money on your Shipping & Handling and need to start either charging more, or looking for cheaper packing materials or lower postal rates (i.e. Could you ship First Class instead of Priority?).
A summary of how to record different kinds of transactions into your Accounts.
Every activity that takes place within your business is a Transaction - making a sale, paying a bill, buying inventory. It is the accumulation of your monthly Transactions that summarizes what your business did in a given month. Using the simple Chart of Accounts I presented above, the following examples are the basic Transactions you would encounter while running a small eBay business. Always remember, that each individual transaction must be in balance (Debits = Credits)
1) Let's start with the assumption that you have $100 you are going to use to start selling on eBay. The journal to record this Investment by the Owner (that's you) would be:
100 CASH Debit $100.00
900 EQUITY Credit $100.00
2) You go garage sale shopping and spend $10 on 5 pieces of merchandise. You would record the Purchase of Inventory as:
300 INVENTORY ON HAND Debit $10.00
100 CASH Credit $10.00
3) You list the first 2 items on ebay, and sell one of them for $7.00, plus $3 Shipping & Handling. You would record the sale as:
200 ACCOUNTS RECEIVABLE Debit $10.00
1000 SALES REVENUES Credit $7.00
1100 S&H REVENUES Credit $3.00
And you would need to transfer 1 of the 5 widgets from Inventory to Cost of Goods Sold. If you bought the items together as a lot, calculating the average cost per item makes sense so the entry would be:
2400 COST OF GOODS SOLD Debit $2.00
300 INVENTORY ON HAND Credit $2.00
3a) The buyer pays via Paypal right away, so you'd record the receipt of payment as:
100 CASH Debit $10.00
200 ACCOUNTS RECEIVABLE Credit $10.00
but there are fees for that Paypal payment:
2100 PAYMENT PROC. FEES Debit $0.59
100 CASH Credit $0.59
4) You use a recycled box and leftover packing peanuts to pack the item for shipment, go to the post office, and the postage comes to $2.67, and you pay cash.
2200 POSTAGE EXPENSE Debit $2.67
100 CASH Credit $2.67
5) At the end of the month, eBay sends you a bill for the fees you owe them for listing your items, and for your successful sale. We'll assume your bill is $1.17. Since you won't pay the bill until next month, you'd record it as:
2000 SALES FEES Debit $1.17
700 ACCOUNTS PAYABLE Credit $1.17
So how did you do this first month? The way to find out is to add up all of the REVENUE accounts, and subtract all of the Expense accounts. If you have a positive number left over - congrats, you made money! If not, better luck next time! You still have four items to sell, so time to create more listings and see what happens!
So let's see how we did!
Using the transaction information from up above
Our Total Revenue was $10.00 ($7 sales price and $3.00 S/H fees).
Our Total Expenses was $6.43 ($2 for the item cost, $2.67 postage expense, $.59 Paypal fees, and $1.17 eBay fees).
$10.00 - $6.43 = $3.57 of profit! YEAH!! (OK, its not much - but you have to start someplace!)
Your total assets are currently $104.74 ($96.74 in cash, and $8 in inventory). Your liabilities are $1.17, and your Owners Equity is $103.57. To double check that you're in balance you would use the Assets = Liabilities + Equity equation. $104.74 = $1.17 + $103.57
Rinse and repeat to build a business!
Seriously though, this was a very simplified example. For the very smallest seller who might only list 5-10 items a month, doing it by hand isn't a big deal. Start selling 250 items a month, and you can see how tedious this could be! That's why software packages are such a great tool - the software understands the way to create Transactions and calculate Account balances, even if you don't. They generally have interfaces that make it easy to enter your transaction information, and they generally have help tools and how-to books that go with them to help you get up and running.
When I first started selling, I did my books by hand in ledger books like I told you about earlier, and then upgraded to spreadsheets. Eventually I outgrew my spreadsheets and got a freeware software package. I then outgrew THAT and currently use Peachtree Accounting software to run my business. It gives me the tools to run reports, do analysis, and saves me time I can use for doing other things to run my business - like creating more Squidoo lenses and knitting more doll and bear sweaters.
Software allows you to keep track of so many things - unpaid bills, uncollected sales, analysis of your shipping & handling fees, your eBay fees as a % of sales, etc. I've included links to some software packages you might explore if you think doing things by hand would be too involved or complicated for you.
But if you are a new seller just starting out, and only selling a few items a month - this very basic system would let you keep the necessary records to see if you're making money, and be ready to fill out that Schedule C at the end of the year.
If you're ready to invest in a software package, I'd have to recommend Peachtree Accounting based on my personal experience with it, although another popular product is Quickbooks. I've provided links below to the two 'starter package' level versions of each software so you can compare them.
If you're ready to invest in a software package, I'd have to recommend Peachtree Accounting based on my personal experience with it, although another popular product is Quickbooks. I've provided a links below one version of Peachtree you might be interested in looking into.
Using Peachtree Accounting software to record transactions saves time,
can prevent a lot of mistakes, and is easy once you get the set up done
Setting up your Peachtree system is probably the most complicated of transitioning from a paper to an electronic system. However, once the basics are in place, then you just have to record your sales & receipts from customers and purchases & payments to vendors. The User Guide that comes with the software provides step-by-step instructions for each of the basic tasks you'll need to do, recording sales, recording payments received and sent. You don't have to cut your checks using their check printing system - just record them as if you did, and pay via whatever method you normally use. Peachtree comes with a basic Chart of Accounts you can use, or you can customize your own like I've done, to be much more detailed. I wouldn't recommend doing that for beginners. A few things I would do is change the names on accounts to match what you'll be using them for. As an example, if you only sell on eBay, change Accounts Receiveable to Accounts Receivable eBay. That way if at some point in the future you open a website, you can add the additional accounts you need and use the existing accounts as a guide for what to do.
I created separate sections in my Expense codes for different categories of fees, one set of numbers for Sales Fees and one set of numbers of Payment Processing fees, one for supplies, and one for Cost of Goods Sold broken out by venue. If there are expense codes in the default list you wont use, just edit them and change them to ones you will use. As long as you don't create new accounts, you won't have to mess with editing the existing Financial Reporting functions that come with Peachtree. The user's manual will help walk you through that process.
You can then add customers as you make sales. I use a 10 digit numbering system, and put the eBay ID as the customer name at the top. This way, I can do a "Find" in my customer database to see if that buyer has shopped from me before.
More Peachtree Tips
* Always record your transactions in a timely manner - it's more difficult to record a week's worth of work on Friday, instead of doing each day's work as it happens.
* Always run your month-end reports - including balance sheet and income statement. The Income Statement is the important one, as that will tell you if you made any money that month, and if so how much. The Income Statement will also be used at the end of each year to complete your Schedule C for tax purposes. You can also monitor unpaid bills and unpaid sales using the graphical reports included under the "My Business" section.
* In addition to your user's manual, there are online resources you can turn to for additional help in getting your system set up and running. As Peachtree allows you to run multiple companies in the same software, you might set up a demo company to experiment with and practice on, before creating your actual company.
* Peachtree allows you to have 2 open fiscal years at one time. Most of you would be running on Calendar year fiscal years, so you would want to leave Year 1 open until you have completed everything related to December (bills not paid until January, customer payments not received until February perhaps). You'll also want to do a year-end inventory, so you can make any adjustments in your Inventory figures before closing the books on December. Once you're sure December is done, re-run your reports to see if anything changed, and use the Year-End Wizard to close Year 1 and open Year 3. Your income statement will provide the data you need to complete your Schedule C as part of your Form 1040 for tax purposes.
* Repeat this process each year.
If you're ready to invest in a software package, I'd have to recommend Peachtree Accounting based on my personal experience with it. This is the "starter level" package below and cheaper than on Amazon!
Would you like more information about Peachtree Accounting software?
For a small online seller, I'd recommend the Peachtree First Accounting 2008, it is the starter package. In future years, as your business grows, your accounting software can grow with it with more complex systems.