I spend a lot of my time talking to Amazon sellers. In the past month alone, I had video calls with 24 FBA sellers (Fulfillment By Amazon), 7 FBM sellers (Fulfillment By Merchant), and 5 Arbitrage sellers. It is really inspiring to hear the success stories of sellers from around the world, and I plan to compile those stories in this blog for us all to learn from, but I am much more intrigued by the recurring challenges that nearly every Amazon seller broadcasts. I decided to compile the results of my favorite informal polling question, and the results have been fascinating. My favorite question to ask other Amazon sellers is…
“What is your biggest weakness as an Amazon Seller?”
How would you answer my question? 80% of my surveyed audience has a similar response → “Bookkeeping and Accounting.” Prior to Fetcher, my answer as an Amazon seller would have been the same! Amazon sellers love to talk about product niches, optimized listings, and daily sales, but turn the conversation to balance sheets, taxes, and asset management, and even the most confident FBA bosses shudder.
Understandably, sellers are primarily focused on generating more sales, and they spend most of their intellectual horsepower getting better at it. Experienced Private Labelers, for example, know the blueprint to FBA success inside and out…
1) Identify a high demand, low supply product
2) Manufacture in China and ship to Amazon fulfillment centers
3) Setup an optimized product listing on Amazon.com
4) Get reviews and run paid advertisements
Wait, but what comes after step 4?
5) Assess and manage the financial performance of your business
Now we’re getting to that uncomfortable phase.
We all know how to log in to Seller Central and check our daily sales in the Business Reports section. That is the fun part! But, do you really know how much profit is left over after you factor in shipping costs, refunds, promotional giveaways, and those pestilent Amazon fees? Do you know the value of your unsold inventory? Do you know the valuation of your Amazon business?
If your biggest weakness as an Amazon seller is related to bookkeeping and accounting practices, you have come to the right place. Today, we will focus on the basics of bookkeeping and accounting. As my football coach used to say, “Before you can play a game of football, you have to be able to block and tackle.” Blocking and tackling are the basics of football. What is the equivalent in the bookkeeping and accounting world? Financial Reports! WOOHOO, are you getting excited?
There are two financial reports that every Amazon seller should become intimately familiar with. The Profit and Loss Statement and The Balance Sheet. They are your friends. Think of them as a tools, similar to a looking glass. These tools will help you peer deep into the heart of your business and retrieve the information you need to make good business decisions. Without the looking glass, you can not get the full picture, and your future business decisions will suffer.
1)PROFIT & LOSS STATEMENT – PERFORMANCE EVALUATION
The Profit and Loss Statement (P&L) is to business finance, what the Rose Bowl is to College Football – “The Granddaddy of Them All!” In large publicly traded corporations, this is the primary document that executives use during quarterly reviews with Wall Street to demonstrate the capabilities of their business. The Profit and Loss Statement offers the best overall view of your bottom line, which is also known as “net income.”
For Amazon sellers, the Profit and Loss statement is one of the best tools for evaluating the past performance of your business. Net income is calculated by adding up all of your various business expenses like Pay Per Click campaigns and monthly Inventory Storage Fees, and subtracting them from total revenue. Net income is also what is used to determine taxable income in a given year.
Creating an automated and accurate Profit and Loss statement is tricky. That is why we created Fetcher! Let’s look at one of my Amazon products inside Fetcher’s P&L Statement.
The top section of every P&L statement is “Revenue.” I selected a relevant date range to give us a nice clean comparison of this example product in June and July. The first thing I notice is that the business grew by over $4000 from June to July! That is great news, but it could also affect inventory readiness. Clearly, demand for this product is growing, so it might be time to contact the supplier and boost production to avoid an inventory stockout. Tip – Fetcher has a daily inventory tracker and projection tool on the dashboard page.
I also notice that the return rate for for this product is less than 5%. That tells me that customers are overwhelmingly happy with the product, and the supplier quality is on point. However, this is a useful piece of data to use when negotiating with my supplier. I will probably ask my supplier for 5% more units in the next shipment, free of charge, to cover quality-related returns.
Now let’s look at expenses.
My first observation is that my expenses growth didn’t exceed revenue growth. That is a relief! Earlier, when we saw that revenue grew by ~35% from June to July, a little hazard light went off in my head, and I was worried that my advertising costs might have spiraled out of control. Overall, I am happy with the scalable growth of this product, and the profit margins. The P&L statement gave me the information that I needed to make a decision about the future of this product. I will definitely invest in another batch of inventory and continue to build this brand.
When setting up your Profit and Loss Statement, it is also important to consider which accounting method you are going to use. The two methods, Cash basis and Accrual basis, use different timing mechanisms to recognize revenue.
Cash basis accounting: revenues are reported on the P&L statement for the period that cash is received by customers
Accrual basis accounting: revenues are reported on the P&L statement when they are earned. This often occurs before cash is received by customers.
The Accrual method is consistent with Generally Accepted Accounting Principles (GAAP) and is considered to paint a more accurate picture. Fetcher uses the Accrual method, and it is what I recommend for most Amazon sellers. Okay, that was dull. Let’s move on.
2) THE BALANCE SHEET – HEALTH EVALUATION
A sibling to the Profit and Loss Statement, the Balance Sheet is another favorite financial statement among business executives. You might be asking “but wait, I thought my P&L was enough! Do I really need another financial statement?” The answer is a resounding “YES!” The reports go hand in hand. Let me explain.
The Balance Sheet is necessary because your P&L Statement is missing some key components of your business, and therefore provides an incomplete picture. The Profit and Loss statement doesn’t account for the value of unsold inventory, or the money that you borrowed to order your next shipment, or how much you owe in sales tax. The Balance Sheet covers that stuff, making it unique because it is the only financial statement that presents an accurate snapshot of the health of a business at a specific moment in time. It tells you the financial position of your company.
Stick with me as we dive deeper into the abyss of the accounting world. Click the link for little added motivation and distraction from the dullness of accounting. Don’t forget to come back up for air.
Back to the wonderful world of accounting. So, you may have heard of the “accounting equation” before. The accounting equation is a simple way to understand financial position and how the components on a balance sheet relate to each other. The accounting equation varies slightly depending on the structure of your business entity.
For the sake of this post I am going to assume that the vast majority of Amazon sellers elect to structure their businesses as “sole proprietorships,” meaning that their businesses are run and owned by one natural person, and that there is no legal distinction between the owner of the company and the business (“corporations” are different because one or more owners may participate as shareholders). For Sole Proprietorships, the accounting equation looks like this…
ASSETS = LIABILITIES + OWNER’S EQUITY
Lets define each part of the equation.
Assets: the resources that you own. Eg: 500 garlic presses valued at $5 a pop.
Liabilities: what you owe to others. Eg: $350 in sales tax payable.
Owner’s Equity: the difference between assets and liabilities. Eg: $2,150
Rather than listing a business’s expenses and income, the balance sheet is a two-sided document. Assets go on one side, and Liabilities and Equity go on the other. Here is an example.
Not surprisingly, the objective of the “balance sheet” is to balance both sides of the document. The total of both sides of the balance sheet should show the same amount, which would confirm that your business sheet is properly balanced.
The Balance Sheet is a more advanced tool, but I recommend Amazon sellers start with a simple excel spreadsheet like the one pictured above.
The Profit & Loss Statement and The Balance Sheet are the most critical reports to start utilizing, but I could not in good conscience take off without talking about the Cash Flow Statement.
Revenue is vanity, Profit is sanity, CASH is reality!
3) CASH FLOW STATEMENT
This report tracks the flow of working capital into and out of a business during an accounting period. It exists because no other report accounts for the complexity of cash flow over time. For FBA sellers, I would recommend using the Cash Flow Statement quarterly. FBM sellers have to worry about additional cash flow factors and should probably manage this report monthly, at a minimum.
A cash flow statement starts with the company’s total cash balance, which is easily found in the balance sheet here…
Take that starting cash balance and consider the flow of cash to the 3 major areas of your business. All inflows to the business are net positive events, and all outflows from the business are negative events.
Operating activities are the primary source, and consumer, of the company’s cash. This includes income from sales on Amazon, and the costs of paying your supplier and freight forwarder. The payment of income tax would also also be considered an outflow in this section.
Investing activities involve buying and selling assets that are not related to the inventory. Fulfillment By Merchant sellers would need to include the purchase of equipment (packaging materials) and property (warehousing) as outflows on their cash statement.
Financing activities include stuff like repaying debt and borrowing money. If you took out a loan to pay for your inventory, that amount would be tracked as an outflow here.
Once you account for all of the inflows (positive) and outflows (negative) events within Operations, Investing, Finance, you are left with your new cash balance for the period. Voila!
Here is an example structure of simple Cash Flow statement for an FBA business.
For more details on the Cash Flow statement, check out Investopedia – the world’s largest digital financial education platform. It is a great resource for learning more about these financial reports.
Well there you have it! We covered the two critical financial reports that every Amazon seller should be using to their advantage, and we even covered the allusive Cash Flow statement. You are all accountants now. Please leave any questions in the comments section and I will get back to you. If you need more specific help setting up your first Balance Sheet or P&L, feel free to give me a shout at [email protected].