250 Accounting for Amazon with Penny Lowe Part 1
It’s long overdue that we’ve had an accountant on Amazing FBA. Today I’ll be sitting down for part one of my interview with Penny Lowe, owner of Wellington Consulting. If I had to name one single item as the most significant pain point for most entrepreneurs, it’s accounting. So many people in all walks of business struggle with tax accounting, bookkeeping, and payroll. It’s impossible to cover everything accounting in just an hour’s worth of interviews, but today in part one of this two part series on accounting, we’ll be covering the basics for new sellers on Amazon.
Registering as a Sole Trader vs. Limited Company
There are advantages and disadvantages to running an Amazon business as a sole trader or limited company. The first question in setting up a company is trading name. As a limited company, it’s essential to find out if the name is available. As a sole trader, it’s still a good idea to make sure the name is available in the event a business should need to become a limited company after doing business for a time as a sole trader. The rules for sole traders regarding tax reporting and obligation are less strict than those of a limited company. As a sole trader, one can use a portion of many expenses to offset other income; as a limited company, the rules are much much stricter, both in the way in which one keeps books and in what can be claimed as an allowable expense.
From an ease point of view during the first few months of running a company, you may want to choose to do business as a sole trader. You’ll have a three month period in which you don’t have to register. That means if you decide after two months this industry isn’t for you, you won’t have spent all your time and money registering a business you’ve got no intention of getting off the ground. Conversely, if after two months business is booming, you can have the option of skipping registry as a sole trader altogether and move on to becoming a limited company. Do keep in mind though that if you want to switch your Amazon or bank account from sole trader to limited company, you may not be able to do that without starting over from scratch. If you’re serious about the business of selling with Amazon, jumping straight to registering as a limited company may be the right choice.
Setting up a Limited Company
Whether you decide to do it yourself or use an online or brick-and-mortar solution to set up your limited company, the process is quite simple. One of the things you need to decide is where you’re going to have your registered office. It can be your home. It can be a family member’s home. Just make sure as part of your rental agreement you’re not restricted from running a business at your address. You can change your address later, so don’t fret too much over this. Once you’ve made this decision, you’re ready to begin the process of setting up your company. Keep in mind there are some restrictions on who can and can’t set up a limited company; for example, you can’t serve as director of a limited company if you’re bankrupt.
The next step in setting up a limited company is choosing a name. Penny likes to search the web for names that are the same or similar to the name of the new company. Should there exist a name similar to the one you’ve chosen, it may be a good idea to pick another. Changing the name of a company later due to legal considerations can mean serious headaches down the road.
People often assume that a business name, the brand name, and the name you’re selling under are one in the same. There can, however, be more nuance. My pro-tip is to make the name you’re trading under on Amazon different than that of your limited company. The reason for this is not because you’re trying to fool any consumers; it’s because the only people who would be interested in that are people trying to reverse engineer your business and steal your best product ideas. If you’re going to trade under a different name than your limited company name, it’s worth letting your bank know that information. It can be tough to accept checks or payments made out to a business name not already registered with your financial institution.
When a new seller buys something and sells it off, often they think the only cost is the purchase of the item. In addition to the cost of the item, a seller can also incur commission fees, delivery fees, PayPal fees, and sample or replacement costs.
Damaged or defective items are an inevitable cost of doing business in the online sphere. For every piece of merchandise damaged either in transit or by the result of a defect, Amazon sellers need to account for a loss in revenue. Say you’ve got a particularly unreliable batch of products in the Amazon fulfilment warehouse. One in every 50 needs to be replaced. Each time that product needs to be replaced, the cost of the goods sold and expedited shipping need to be included in the price of the other 49 items in the batch.
Attributing costs like samples from the manufacturer can be a bit trickier. Sometimes samples garnered in the early stages of product development make more sense from an accounting perspective as research and development costs than they do as distributed costs per item. Five samples of the same product from the same manufacturer can be easily distributed over the price of the item for the duration of the sales period. It gets more complicated when there are samples of multiple items from multiple manufacturers, especially if only a percentage of the products ever get to market. Costs such as these are better expressed as line items similar to those for an accountant or graphic designer’s services. Just make sure your profits are enough to cover these expenses.
Overhead vs. Direct Costs
In simple terms, a direct cost you would not incur if the product doesn’t go to market. Overhead costs you would have to pay anyway. Things like telephone, electricity, and internet costs are considered overhead. Manufacturing and product marketing expenses are considered direct costs. Understanding the distinction between these two types of expenses can help not only with cash handling and list pricing but also with filing taxes.
Tax accounting and management accounting are both vital to the operations of a successful business. Everyone knows if you don’t pay your taxes you’ll wind up a failed entrepreneur. The pitfalls of failure in management accounting can be more subtle and take years to understand and correct without proper professional help. Whether you decide to tackle management accounting on your own or pay a professional, it’s smart to invest in accounting software like Quickbooks or Zero. Spreadsheets are an acceptable solution. However, since they’re not rigidly designed with accounting in mind, mistakes are more commonplace. When starting out, it can be acceptable to look at your expenses with a big-picture perspective, but as you grow, you’ll want to pay more and more attention to the management accounting side of the equation.
Using Quickbooks to Monitor Expenses
Quickbooks is an all-inclusive accounting solution. It’s important to set up headings and itemize your expense categories so you can make sure you’re monitoring expenses. One of the failures many small business owners experience is in recurring monthly expenses. Without an itemized expense reporting solution like Quickbooks, monitoring and evaluating the viability of these subscription-based solutions from an accounting perspective can become untenable.
Accounting for Amazon Businesses 101:
Business accounting can get out of control fast. It seems there are thousands of little expenses and deductions of which we need to keep track every month. One of the most critical data streams we need to keep track of and analyze regarding management accounting is raw units sold. Seasonal products require a different kind of inventory management than products with year-round demand. It’s also important to keep track of product individual item costs from production run to production run. New Amazon entrepreneurs tend to overanalyze. Keep an eye on currency conversion rates, but if you’re looking at six decimal places of currency fluctuation, stop. It’s better to think big-picture about things like currency.
Penny’s Advice for Budding Entrepreneurs
Instead of thinking about starting a business, use the analogy of changing cars, what thoughts would go into that decision? What do you need to get out of this new car? How much can you afford to spend on it? How long do you plan on keeping it? And How are you going to finance the purchase? These questions all apply to setting up a business as well.
Treat your business like a business. Don’t quit your job and venture off into your new life as an entrepreneur with your bank account in the red. Don’t use credit before you understand your profit margins and cash flow rate. Credit increases risk. Give yourself a financial cushion.
Check out part two of my interview with Penny on 18 May 2018.