There are two distinct models in the ever-evolving commerce space. e-commerce, driven by the digital revolution, has reshaped the way we buy and sell. Meanwhile, traditional retail maintains its enduring presence.
In 2022, retail e-commerce earned more than $5.7 trillion worldwide. While the boom in online shopping is rising steadily, it won’t take over in-person shopping anytime soon. Brick-and-mortar retail recorded $21.6 trillion in the same year.
These models continue to coexist with their unique set of challenges and opportunities. Although e-commerce and traditional retail both deal with selling goods or services, their accounting practices differ in several ways. This article delves deeper into this topic and unfolds more information on how they differ in key areas.
What Is E-commerce Accounting?
E-commerce accounting is a specialized financial management system tailored to the unique characteristics of online businesses. It separates itself from general accounting or traditional retail accounting due to the digital landscape’s intricacies, high volume of transactions, and dynamic nature.
In e-commerce, transactions unfold swiftly in virtual marketplaces, often spanning international borders. Tracking inventory, monitoring cash flow, and ensuring compliance with tax regulations in this environment demand agile and technologically driven accounting systems.
5 Reasons Why E-commerce Accounting Is Indispensable
The significance of e-commerce accounting cannot be overstated. Here are the top reasons why it’s crucial for online businesses:
1. Manage High Transaction Volumes
E-commerce enterprises frequently handle a vast number of transactions daily. Specialized accounting systems streamline the tracking and reporting of these high volumes efficiently.
2. Sell on Multiple Sales Channels
Unlike physical stores, getting your business online often means leveraging various platforms. This includes websites, marketplaces, and social media. Managing these diverse channels demands specialized accounting to consolidate data efficiently.
3. Ensure Tax Compliance
Navigating the intricate web of tax regulations is a unique challenge in e-commerce. This is especially so when dealing with international customers. Proper e-commerce accounting ensures compliance and avoids costly penalties.
4. Maintain a Stable Business Model
Accurate and up-to-date financial records provide insights into a business’s financial health. This enables them to make informed decisions and keep their operations in optimal status money-wise.
5. Gain Investor Confidence
Financial transparency is a critical factor when seeking external funding. Specialized e-commerce accounting not only wins the trust of potential investors but also supplies them with the necessary financial data to support investment decisions.
Unique Challenges in E-commerce Accounting
For the most part, the digitization that largely comes with e-commerce accounting makes it more convenient and streamlined. Transactions are automated, and records are accounted for accurately. However, these merits also present distinctive challenges that demand specialized expertise.
One such hurdle is navigating the complexities of handling diverse currencies. Putting your business online allows you to expand beyond your locale. Serving a global clientele makes it necessary to manage meticulous currency conversion and reconciliation amidst fluctuating exchange rates.
As a cornerstone of e-commerce, digital marketing also introduces intricate expense management. Tracking and allocating costs associated with advertising, search engine optimization, and social media promotions requires you to learn and use specialized software and strategies to gauge their effectiveness. Therefore, you need a bookkeeping model that can properly account for these costs and assess your campaign’s return on investment (ROI).
You might also have to branch into subscription-based revenue streams. Ensuring the accuracy of subscription renewals, cancellations, and modifications is essential for maintaining a steady cash flow and making reliable revenue forecasts. This underscores the critical role of e-commerce accounting in keeping your business afloat online.
What Is Traditional Retail Accounting?
Traditional retail accounting is the practice of managing financial transactions and records for brick-and-mortar stores. It is distinct from e-commerce accounting in that it primarily deals with tangible, face-to-face transactions.
This type of accounting focuses on the financial aspects of physical retail operations. It encompasses the recording, tracking, and analysis of monetary transactions, inventory, expenses, and revenue generated through in-store purchases.
5 Reasons Traditional Retail Accounting Remains Relevant
With the digital shift, traditional accounting can easily be overlooked. However, these five reasons underscore its continued relevance in retail.
1. Convenience Supremacy
In-person transactions are immediate and straightforward. Retail accounting systems with face-to-face exchanges are easier to manage.
2. Lower Transaction Volume Handling
Compared to e-commerce, traditional retail typically experiences a lower volume of transactions. This simplicity allows for efficient record-keeping without the complexities of online transactions.
3. Simplified Calculations
In traditional retail, the calculation of sales, taxes, and change is simpler, reducing the chances of errors and discrepancies.
4. Streamlined Inventory Assessments
Physical inventory counts are generally more straightforward compared to the intricacies of tracking digital inventory. This simplifies the process of assessing stock levels and valuation.
5. Easier Financial Auditing
Financial auditing in traditional retail is made simpler by tangible receipts and invoices, providing a clear paper trail and reducing the chances of misinterpretation.
The Challenges in Traditional Retail Marketing
In the physical retail world, customer behavior and preferences heavily rely on the analysis of foot traffic. Collecting, deciphering, and effectively utilizing this data can be tricky. This is why foot traffic analytics remain a major hurdle to traditional bookkeeping.
Another distinct challenge lies in the area of physical inventory counting and valuation. Unlike their digital counterparts, physical inventory items require periodic manual counting. The accuracy of these counts and subsequent valuations is a top priority to prevent discrepancies and stock-outs. This is crucial to ensuring a seamless shopping experience for customers.
Key Components of E-commerce Accounting vs. Traditional Retail Accounting
E-commerce and traditional retail represent how today’s consumers and entrepreneurs participate in buying and selling. Explore further how these two work differently in different essential elements of accounting.
Revenue Recognition
Revenue is the lifeblood of accounting and businesses in general. It measures a company’s performance and growth. It’s also the foundation for calculating profitability and making strategic financial decisions. Find out how each model accounts for their revenue.
Cash Method
Revenue is recorded when cash is received, typically at the point of sale. It’s a straightforward approach and is relatively easy to track.
This is popularly practiced in a traditional retail setting as it aligns with immediate in-person exchange. While it can be applied to e-commerce, the process can be more challenging when it comes to online transactions. E-shopping usually involves deferred payments, shipping periods, and others that contradict the cash method’s direct system.
Accrual Method
The accrual method recognizes when it’s earned, not necessarily when the cash changes hands. This is commonly done by e-commerce due to the complexities of online sales. When practiced in traditional retail, revenue is recognized when a sale is made, regardless of whether a payment reaches the business’ account.
This is the most common method used in various businesses and financial institutions. It offers a more accurate depiction of a company’s financial health, especially for businesses with extended payment terms.
Subscription Models
A subscription is a recurring payment plan where a customer makes regular payments at a specific term (e.g., monthly, quarterly, or annually) to access products, services, or content over an extended period.
e-commerce businesses frequently offer subscription-based models, such as monthly product deliveries or digital services. While they can be lucrative, they introduce the challenge of managing deferred revenue.
Deferred revenue is the upfront payment for services or products to be delivered progressively. It must be tracked and distributed over the subscription period for precise financial reporting and accounting standards compliance.
Inventory Management
Effective inventory management helps businesses meet customer demands, optimize working capital, and assess their financial state accurately. It also maintains optimal stock levels, preventing overstocking and understocking issues that might incur financial losses.
Here are three common ways to manage inventory in both retail and e-commerce businesses:
First-In, First Out (FIFO)
This method sells the oldest inventory items first. It’s widely used in brick-and-mortar stores, especially for perishable goods. It reflects the actual flow of inventory in most cases and keeps their stocks fresh.
Last-In, First-Out (LIFO)
LIFO flips the script and assumes that the newest inventory items are sold first. While permitted under U.S. Generally Accepted Accounting Principles (GAAP), it’s prohibited by the International Financial Reporting Standards (IFRS) and Accounting Standards for Private Enterprises (ASPE) as it can lower taxable income.
Weighted Average Cost
Average cost finds a middle ground by calculating the average cost of all items in stock. It’s direct and aligns well with businesses that deal with a constant flow of inventory, both in traditional retail and e-commerce.
Drop-Shipping and Third-Party Fulfillment
The lack of physical inventory in some e-commerce businesses introduces two unique inventory practices: drop-shipping and third-party fulfillment.
Drop-shipping allows an online shop to sell products they don’t physically possess. Instead, they ship directly from suppliers to customers. This eliminates the need to stock products and reduces associated costs that are usually tied to an inventory.
Similarly, third-party fulfillment services store, pack, and ship products on behalf of e-commerce businesses. These businesses don’t have their own warehouse and have little involvement with their stocks.
Cost Structure
Costs refer to the value spent by a business to acquire, produce, or maintain goods, services, or assets. Proper cost tracking and analysis enable businesses to make informed decisions about pricing, budgeting, and resource allocation.
The following are the two main types of cost evaluated in accounting:
Variable Costs
Variable costs fluctuate when there are changes in production or sales volume. In e-commerce, variable costs vary significantly. This includes shipping fees, marketing costs, and fulfillment payments. With shipping in particular, online shops must navigate the complexities of shipping rates, international shipping, and customer expectations for free or discounted shipping.
On the other hand, traditional retail businesses generally have more predictable variable costs, such as costs of goods sold (COGS). COGS are expenses directly associated with producing or purchasing the goods being sold. They go up as the sales volume increases, in which businesses adjust their spending in line with their revenue.
Fixed Costs
Fixed costs remain relatively stable regardless of business activity. In physical stores, fixed costs often include rent for physical storefronts, which must be paid regardless of foot traffic. For online retailers, these can be web maintenance, hosting fees, and subscriptions.
Sales Tax
A sales tax’s accounting implication differs significantly between in-person storefronts and e-commerce platforms. In domestic taxation, local retailers typically deal with tax regulations within a single jurisdiction.
In traditional retail, sales tax implications are relatively straightforward. Businesses generally collect and remit sales tax based on the location of their physical stores, making compliance more manageable.
E-commerce faces a more complex tax scenario. They fulfill tax compliances in multiple jurisdictions. Each online sale may be subject to different tax rules depending on the buyer’s location. This requires specialized software and thorough record-keeping to ensure compliance with each jurisdiction’s tax rules and rates.
Payment Methods
Offering diverse payment options is a selling advantage. It serves the preferences of a wide range of customers, enhancing their shopping experience and increasing the likelihood of completed transactions.
Learn in detail how local stores and e-shops differ in their payment methods below.
Diverse Payment Options
Online stores typically offer diverse payment methods, including credit and debit cards, digital wallets, and bank transfers. This provides the flexibility that online shoppers value, enabling worldwide customers to use their preferred payment options.
Traditional retail often has fewer payment options, primarily accepting cash and card payments. While this simplicity can be efficient for in-person transactions, it may limit potential sales from customers who prefer alternative payment methods.
Digital Wallets and Cryptocurrency
Digital wallets and cryptocurrency play an increasingly essential role in e-commerce. They guarantee more convenient, secure, and efficient online transactions. This is especially crucial with rising cyberattacks.
However, accounting for cryptocurrency transactions isn’t simple due to their volatile nature. E-commerce businesses must track and report cryptocurrency holdings accurately to comply with financial regulations.
Returns and Allowances
Transactions aren’t perfect all the time. When crunching the numbers, it’s important to account for returned products or allowances granted to customers due to issues like damaged goods or pricing discrepancies. These adjustments help provide a more realistic picture of a company’s profitability and ensure transparency in financial reporting.
Accounting for Returns
E-commerce generally offers more liberal return policies to attract customers. The ease of initiating and processing returns, often including pre-paid labels, can lead to a higher return rate.
A retail establishment tends to implement tighter return policies. In-person returns are subject to more stringent conditions because they typically carry higher operational costs and limited inventory space. Stricter return policies help mitigate the risk of excessive returns and deter fraudulent or dishonest return practices by customers.
Handling Chargebacks
An e-commerce’s remote nature means it faces a higher rate of chargebacks compared to traditional retail.
Chargebacks occur when customers dispute a charge with their credit card company, often claiming unauthorized or fraudulent transactions. E-commerce businesses must actively manage chargebacks, providing evidence of legitimate transactions to prevent financial losses.
In traditional retail transactions where the cardholder is physically present, the likelihood of chargebacks is lesser. Any disputes can be resolved in-store right away without involving the credit card companies.
Expenses and Overheads
Running a business costs a significant amount of money. Expenses in accounting are costs a business incurs as part of its regular operations. Overheads are a subset of expenses necessary for a business’ daily run but aren’t tied to their production.
E-commerce and traditional retail present the following different expense and overhead needs, specifically in pushing their marketing efforts.
Advertising Spend
It’s no secret that e-commerce utilizes more marketing channels and strategies to drive digital growth. Google’s search engine results page (SERP) is particularly competitive, only ranking 10 websites on the first page. They also rely on social media channels alongside local and international competitors.
Online businesses employ pay-per-click advertising, paid social ads, and search engine optimization to maximize their digital reach. Traditional retail invests more in location-based advertising and foot traffic generation.
Unique Expenses
Launching an e-commerce business incurs expenses unique from setting up a local shop. These costs include ensuring your website’s availability, performance, and security, such as the following:
- Server and hosting plan
- Domain
- Web development and maintenance
- SSL and other security features
- Customer service channels
Suggested Graphics: List of unique expenses with icons
Reporting and Compliance
Accurate financial documentation and compliance uphold a business’ integrity in front of stakeholders, investors, creditors, and customers. Here are some financial statements and compliance businesses need to adhere to regardless of their medium.
Financial Statements and Reports
All businesses, regardless of where and how they operate, require the following standard financial statements:
- Income statement: This is a summary of a company’s revenues, expenses, and net profit (or loss) over a specific period, typically a quarter or a year.
- Balance sheet: A snapshot of a company’s assets, liabilities, and shareholder’s equity.
- Cash flow statement: The cash flow statement tracks a company’s inflows (e.g., sales, investments, financing) and outflows (e.g., operational costs, debt repayment).
- Statement of retained earnings: This statement demonstrates how a business’ accumulated profits are used to either fund growth or pay dividends to shareholders.
Regulatory Compliance
Getting your business online means operating in a global environment. Compliance with international standards and online regulations is vital. This includes data protection laws, tax regulations for cross-border sales, and compliance with online payment processing regulations.
Accounting the Right Way: Online or Offline
Doing business in the present means navigating online and offline channels to maximize every business opportunity. This also means understanding the accounting differences between a brick-and-mortar storefront and an e-commerce platform.
E-commerce relies on flexible payment options, faces unique expenses related to its digital presence, and grapples with the complexities of online regulations. Traditional retail leans towards direct payment methods, location-based sales, and gaining foot traffic.
Knowing these differences is crucial for making informed financial decisions and maintaining compliant, profitable operations. Business owners and accountants alike must adapt to these diverse practices to ultimately pave the way for success in the modern business world.
Resources
Brick and Mortar (vs E-commerce) Statistics: Latest 2023 Data. (2023, August 29). Capital One Shopping. https://capitaloneshopping.com/research/brick-and-mortar-retail-statistics
E-commerce Accounting: A Beginner’s Guide for 2023. (2023, August 20). Shopify. https://www.shopify.com/blog/ecommerce-accounting
Fernando, J. (2023). Cost of Goods Sold (COGS) explained with methods to calculate it. Investopedia. https://www.investopedia.com/terms/c/cogs.asp
Four types of financial statements. (2001, May 9). William & Mary. https://online.mason.wm.edu/blog/four-types-of-financial-statements
Guest, S. (2023, May 24). Increase In Cyberattacks: Is Your Business Safe? Forbes. https://www.forbes.com/sites/sap/2023/05/24/increase-in-cyber-attacks-is-your-business-safe/?sh=2976dd3d6fa2
Kenton, W. (2022). Foot traffic: definition, tracking, ways to increase. Investopedia. https://www.investopedia.com/terms/f/foot-traffic.asp
Laurinavicius, T. (2023). E-commerce Accounting 101 + Best Practices | BigCommerce. The BigCommerce Blog. https://www.bigcommerce.com/blog/ecommerce-accounting/
Magill, D., & Magill, D. (2023, September 6). E-commerce Accounting Basics: Principles for a successful Store. WooCommerce. https://woocommerce.com/posts/ecommerce-accounting-basics/
Mailchimp. (n.d.). SERP | Everything you need to know about Search Engine Results Pages | Mailchimp. https://mailchimp.com/marketing-glossary/serp/
Segal, T. (2023). What is a chargeback? Definition, how to dispute, and example. Investopedia. https://www.investopedia.com/terms/c/chargeback.asp
Small business guide to retail accounting – Business.com. (n.d.). business.com. https://www.business.com/articles/retail-accounting-guide/
Team, C. (2023). Last-In First-Out (LIFO). Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/accounting/last-in-first-out-lifo/
Topic: E-commerce worldwide. (2023, September 26). Statista. https://www.statista.com/topics/871/online-shopping/
Tun, Z. T. (2021). Why LIFO is banned under IFRS. Investopedia. https://www.investopedia.com/articles/investing/042115/why-last-first-out-banned-under-ifrs.asp
What is the Retail Accounting Method, Exactly? (2023, March 9). Lightspeed. https://www.lightspeedhq.com/blog/an-in-depth-look-at-the-retail-accounting-method/
