Understanding your expenses and how to manage them is essential to the survival of any ecommerce business. Your expenses affect the final price of products and are also tax deductible. But if you sell online, losing track of your expenses is a problem that can turn into a nightmare very quickly.
What is Considered Expenses?
Well, expenses are the cost of running your business. It is one of the accounts listed in a company’s chart of accounts and general ledger. Let’s apply two basic, but very crucial, accounting concepts to break your expenses down. These concepts are the direct and indirect costs that make up your total Cost of Goods Sold (COGS).
Types of Expenses
Here’s a breakdown of the indirect and direct expenses that all online retailers should be tracking to make sure their company survives and thrives.
Direct costs refer to what you spend in the production of goods and services.
Most ecommerce sellers operate by reselling products that were manufactured by others. Manufacturers are responsible for making a product that consumers want to buy while the 3rd party seller takes on the role of digital merchant, shouldering the risk of marketing the product and actually making the sale. Regardless of the pricing model you adopt for your business, all of your expenses should be taken into account.
Packaging and Shipping
Packaging supplies are a seemingly small expense that can eat away at your margins if you’re not careful. Simple things like packing boxes, tape, bubble wrap and postage are costs that you’ll have to consider and factor into the price of your products. Buying materials in bulk lets you negotiate better prices with suppliers. This can lead to huge savings over time. Thankfully, companies like Uline and Value Mailers offer packaging and all sorts of other supplies at progressively discounted rates.
As far as shipping goes, online sellers can get big discounts through major carriers or through partnerships with ecommerce platforms such as shipping software with heavily discounted postage.
Sellers using FBA need to take inventory storage and fulfillment costs into account to make sure expenses don’t get out of hand.
Indirect costs on the other hand are the overhead expenses that keep your business running.
Advertising and Consulting
Since your customers will be shopping online, advertising on the websites where they hang out is your best bet when it comes to increasing sales. This is where paid search advertising comes into the picture.
If you want your page to appear on the first page of search engines like Google and Yahoo, buying ad space will be the fastest way to do it. This involves bidding on high volume keywords and phrases associated with your products.
It’s important to keep in mind that your spending on keyword bidding will be a variable expense that changes depending on how many competitors are in the mix and even on the time of day. Your keywords will definitely be more expensive during peak traffic hours, but your sales will also be greater!
Investing in paid search on social media platforms like Facebook, Instagram, or Twitter is another great way to increase your online exposure. Ads for your products will appear on a user’s news feed when they log in. Potential customers can be targeted based on demographics and their search history.
While highly effective at boosting sales, this method of advertising can get pricey if you’re not careful, so it’s important to keep close track of the impact your spending has over multiple channels. Optimizing your ecommerce store for better performance in search engine queries will take longer, but can give you even stronger results in the future as your ranking evolves.
Whichever form of online advertising you choose, it’s critical to keep a close eye on ad spend. Hiring a specialized agency to manage your ad budget and increase your search engine exposure may be a necessary step towards scaling your business. A bad return on investment can quickly send any online business into a tailspin.
So what kind of advertising expenses should a small or medium-sized ecommerce business expect? BigCommerce estimates that small businesses spend between 7 and 12% of their total revenue on advertising. When it comes to ecommerce, these numbers skyrocket. According to Vulcan Search CEO Mark Chandavarkar, successful ecommerce sellers will have between 35 and 40% of their total expenses and up to 92% of revenue in search advertising.
Salaries and Payroll Tax
As your business grows, a larger staff may be needed to manage day-to-day operations. When this happens, salaries will become an added expense to track. Depending on the type of employee and compensation structure you negotiate, this may involve a combination of base salaries with performance-related incentives and bonuses.
Any benefits package you offer to attract top talent should also come into the equation. Federal payroll taxes for employers amount to 12.65% of an employee’s salary, divided amongst Social Security, Medicare, and unemployment insurance. State payroll tax policies vary, and will usually mean a slight increase in your insurance bill.
Most online customers find it more convenient to pay for their purchases with a credit or debit card. For online retailers, this means having additional expenses with processing fees.
Aside from buyers and sellers, there are four major players in an online card transaction:
- Credit card associations:
These are the companies that operate the credit card networks – Visa and MasterCard are the most common. They charge transaction fees on every purchase, which is usually a percentage of the sale combined with a flat fee. A higher volume of sales will also mean lower fees.
Customers may also use a card issued by their bank for online purchases. Like the credit card associations, they also charge transaction fees per purchase.
- Credit card processors and merchant account providers:
These folks provide the account you’ll use to process your customers’ payment details. As far as fees go, they usually combine transactional and flat fees with incidental charges. Incidental fees include address verification, retrieval (in case the customer disputes a charge) and batch fees per group of transactions you submit.
- Payment gateways:
Payment gateways provide you with a communication link to your bank which makes it possible to accept online payments. They charge flat fees for their services. Some of the biggest names on the market are Authorize.net, USA ePay, and Quantum Gateway.
On top of all of this, be sure to remember the fees associated with maintaining your regular corporate bank account.
Rent, Supplies, Utilities and Depreciation
If you decide that your ecommerce business needs an office and should store products in a warehouse, rent will be a significant slice of your startup expenses. Storage and depreciation expenses can also take their toll. This is definitely the case if you sell perishable or even electronic products like computers, with component parts that depreciate over time.
When you dropship products straight to your customers, make sure to find out when those products were produced and/or acquired. As an online seller, positive reviews are key to maintaining a successful business. Products that are delivered in less than top shape can work horrors for your reputation and can even result in legal issues with your customers!
IT and Software
It goes without saying that online sellers will need internet and a website. Monthly internet costs vary depending on the size of your operation, but shouldn’t exceed $100 for small businesses. If you open up shop through multiple online marketplaces (i.e. Amazon, Walmart, eBay), you won’t need to worry about web hosting costs, but you will incur fees from each marketplace for each item sold.
But as business expands, you may want to invest in an independent site where shoppers can go to buy your wares directly. Website design prices will vary wildly from the hundreds into the thousands depending on how fancy and user-friendly you want your presentation to be.
To host your site you’ll need a domain name. These can cost as little as $10-12 for new addresses, or a king’s ransom for more established or single word domain names. A business email to contact suppliers and and partners also comes in handy. A Google business account with your domain name included will only set you back around $5 per month.
You will also need to decide on whether to use a ready-made shopping cart or an open-source solution. We’ve put together a comparison guide to help you decide which shopping cart is best for your business.
Cost of Goods Sold (COGS)
Your COGS is one of the most important metrics for maintaining a successful ecommerce business, and every business is required by the IRS to include these expenses on their tax returns. The good news is you can deduct this expense from business earnings to lower your tax bill!
To calculate COGS you need to have a clear understanding of what’s going on with your inventory. We can use this simple formula:
Beginning Inventory + Additional Inventory – Ending Inventory = COGS
So all we have to do is add the inventory you started the fiscal year with to the inventory you acquired, subtracting the inventory you have left at the end of the year. To get an accurate valuation of what your inventory is worth, direct and indirect costs need to be considered. Your direct costs involve the price of the goods you plan to resell, raw materials (and the supplies or expenses related to production), packaging and inventory. Indirect costs include labor-related expenses, storage, administrative costs and depreciation.
Tracking Your Expenses
No matter what stage you’re at as an online seller, keeping track of expenses is key to growing your ecommerce business. We can help you on your journey!
Our inventory management software and reporting tools let you seamlessly track inventory, expenses and your total COGS. We take the accounting load off your shoulders so that you can focus on what you do best, building your business! Start your free trial today!