With Black Friday and Cyber Monday coming, you’re (hopefully) going to make a ton of cash. You know you have to pay taxes on it, and you know you have to do your Shopify accounting in order to do that.
But how does that all work? Do you need to enter a bunch of numbers into Excel or something? Do you need to hire an accountant? Or maybe a bookkeeper? What’s the difference?
It might sound intimidating, but we’ll explain the basics and teach you how to easily keep track of everything. Follow our tips and tax time will be less tear-out-your-hair-and-sweat-through-your-jacket time, more click-a-couple-buttons-then-go-do-whatever-the-hell-you-want time.
Disclaimer: This article covers Shopify accounting and taxes for US-based businesses. International businesses should check their local laws.
Shopify Accounting 101
Ideally, you’ll complete these tasks before you start receiving revenue. But you can complete them even if you’ve already started raking in that moolah. You’ll have to complete them at some point before the tax man comes after you. Best to get it over with ASAP.
Choose a Business Structure
Your options from easiest to set up to most difficult are: sole proprietorship, partnership, limited liability corporation (LLC) or corporation.
Sole Proprietorship – If you don’t choose a business entity, the government will automatically classify you as a sole proprietorship. That means you’ll declare your business profit or loss on your personal income tax return. This is the easiest way to get started, but the biggest downside is that your personal assets are mixed in with your business assets. That means if someone sues your company and wins, they may be able to take all of your jet skis or lamborghinis or whatever cool stuff you personally own.
Partnership – You can set up a partnership if you’re going into business with one or more other people. Your share of the company’s profit or loss is reported on your personal tax return, just like with a sole proprietorship. But partnerships require a few extra steps. Each partner must be issued a W-2 at tax time as well as copies of Schedule K-1. Just like a sole proprietorship, there’s no separation between your personal assets and business assets.
LLC – An LLC can be formed by an individual or multiple owners. They can elect to be taxed as corporations, partnerships or sole proprietors, giving them greater flexibility. However, it’s treated as a separate entity when it comes to employment taxes. That means the LLC must pay and report employment taxes to the IRS, making it a little more complex. The good news is that an LLC separates your personal assets from your business assets. So that crazy customer who sues you can’t take your house.
Corporation – Just like LLCs, corporations separate your personal assets from your business assets. But they have a lot of legal and tax requirements that must be followed. For example, you must hold annual meetings and record the meeting minutes. The forms and setup process are a bit more complex than the other business types, so it’s best to consult with an accountant if you want to form a corporation.
Choose an Accounting Method
Your two options are: cash or accrual.
With the cash method, you record transactions whenever money enters or leaves your business account. For example, if you receive a bill for a business-related expense, you record the expense only after you actually pay it, not when you receive the bill.
With the accrual method, you record transactions when they occur. So when you get that bill, you record the expense even though you haven’t actually paid it yet.
Whichever method you choose, it’s important to stick with it if you want to avoid a nightmare of disorganized transactions and potentially getting punched in the neck by your accountant.
Get a Business Bank Account
If you do nothing else, at least do this. It will make your life so much easier.
When you try to use your personal bank account for business expenses, it gets really difficult to go back and figure out whether that trip to Walmart was for office supplies or cupcakes. And if you say it was for office supplies and later get audited, the IRS will expect proof that you didn’t actually buy cupcakes. That means keeping every stupid receipt and making notes on them when they say something ridiculous like “XRX 4839 100-ct purple moonbeam” instead of “Xerox copier paper.”
Save yourself the headache. Get a separate account and do all your business’ business (heh) through there.
Bonus: Use Doctor of Credit to find a business account that gives you a bonus for signing up and completing a few tasks like depositing a certain amount or completing a certain number of transactions within a set timeframe. Booyah.
Get Accounting Software
Although Shopify will help you keep track of sales taxes and various fees, they don’t offer a full bookkeeping solution for online stores. There are tons of apps in the app store that can help, but the two biggest names in accounting software are Quickbooks and Freshbooks.
Quickbooks Online is a cloud-based accounting and bookkeeping program that allows you to organize income and expenses, pay bills, manage payroll and more. You can link it to your business bank account so that payments automatically get entered and tracked. Pricing starts as low as $10/month.
Freshbooks is similar to Quickbooks. You can use it to track expenses, pay bills and generate reports on your company’s financial health. Freshbooks plans start at $15/month.
Shopify Accounting 201
Congrats, you now understand the basics of Shopify accounting! Take a break to pop a bottle of champagne and celebrate or keep plowing through if you want to level up your accounting knowledge.
Enter and Categorize Income and Expenses
Whenever money enters or exits your business account, it needs to be recorded and categorized. If you’ve set up Quickbooks or Freshbooks and linked it to your business bank account, the recording will be taken care of automatically. You just need to categorize things.
Categorizing will be a pain in the butt during your first month in business. Every time you buy inventory or pay fees to Shopify or purchase gas to take your Amazon packages to the post office, you’ll have to categorize those expenses. These are some of the categories the IRS uses:
+ Advertising and marketing
+ Cost of goods sold
+ Business start-up costs
+ Credit card fees
+ Legal and professional fees
+ Supplies and materials
+ Car and truck expenses
+ Wages and salaries
+ Internet-related expenses
You may have expenses that belong in other categories and that’s fine. Just name the category something that makes sense and keep things organized and consistent so you or your accountant can easily figure out your taxes when it comes time.
If you’re using Quickbooks or Freshbooks, you can set them up to remember your categories in future months. So every time you pay your internet bill, it will automatically categorize it into internet-related expenses. Sweet.
Organize Your Records
If your records aren’t organized, you can’t back up the info you have on your books. And Uncle Sam will take you to the cleaners for it. So keep everything organized and stored, either digitally or, if you’re old as dirt, in a shoebox. Things you’ll want to keep:
+ Bank/credit card statements
+ Shopify/amazon revenue records
+ Financial statements
+ Previous tax returns
+ W-2 and 1099 forms
+ Any other documentation of income or expenses
Reconcile Bank Statements
Your business bank account should supply you with a statement once a month that covers all the deposits and withdrawals from the account for that month. You’ll want to reconcile this with your accounting software. It’s usually pretty easy – most accounting software has a big “reconcile” button that automatically takes care of it.
Basically, what reconciling means is matching what the bank says to what your books say. Everything should match exactly. If it doesn’t, you’ve got to comb through and find out why.
Tip: Doing this monthly is vital if you don’t want to be kicking yourself at tax time, or worse, running out of money when you need it most. Some people just run their business off their bank balance, only looking things over when it comes time to do taxes. That’s a terrible way to do things because you can’t make educated decisions for your business when you don’t know how your money flows.
File and Remit Sales Taxes
Depending on the states your buyers are in and your company’s revenue in each state, you may need to file sales tax on a monthly, quarterly, or annual basis with each state. That means you have to collect sales tax from your customers, report how much you collected and then remit it to the correct state.
This can get complicated fast, especially when selling on multiple channels (like Amazon and Shopify). But don’t worry, we’ve written a sales tax guide that breaks it down for you.
Pay Estimated Quarterly Taxes
Depending on how much money you make, you’ll probably need to pay estimated quarterly taxes to the IRS. Typically, if you’ll owe taxes of $1,000 or more, you’ve got to pay them quarterly instead of annually. If you decide to wait until April 15th to pay your taxes all at once, it’s not going to be pretty because the IRS is going to hit you with penalties, fees and interest.
So basically, you’ll estimate how much money your business will earn for the year, then divide that amount by four, then pay that amount every three months. You can use the IRS Estimated Tax Worksheet to calculate your estimated quarterly taxes.
Don’t worry if you pay too much, you’ll get the extra money back as a tax refund. But if you underpay by too much, the IRS could penalize you.
Shopify Accounting 301 (Master Pro Expert Ninja Level)
Sweet baby hayzeus, you’re basically trying out for your black belt now. If you want to go from student to master, keep reading.
Analyze Your Financial Statements
If you’re using Quickbooks or Freshbooks, you can generate financial statements automatically (as long as your books are up to date). These reports tell you things like how much cash your business has, how much it owes and a bunch of other stuff you need to know. They can help you forecast revenue, tighten your bottom line, prepare your taxes and plan for the future of your business.
There are three main financial statements used by most businesses:
+ Balance sheet
+ Income statement
+ Cash flow statement
Balance Sheet – This sheet is set up with a line down the middle and all of your assets (cash, inventory, equipment, etc.) on the left side. On the right side are all of your liabilities (debts, accounts payable, etc.). Whenever you add something to one side, you must make the same adjustment to the other side so that both columns balance each other out.
So let’s say you buy $10,000 worth of inventory with $2,000 cash and an $8,000 loan. The $10,000 worth of inventory obviously goes into your assets column, and the $8,000 loan goes under liabilities. But the sheet doesn’t balance yet. You still need to account for that $2,000 cash you paid. Where does that go?
Here’s a super fancy accounting equation: Assets = liabilities + equity. Put another way, the difference between your assets and liabilities is called equity. So in this example, you have $2,000 in equity, which goes on the right side of your sheet along with your liabilities. With $10,000 in assets and $2,000 + $8,000 in liabilities and equity, your balance sheet actually balances.
A balance sheet is considered a snapshot in time. It represents the assets, liabilities and equity in your business on the specific day it was created. It always shows an exact day rather than a period of time.
Income Statement – This shows how much money your business gained or lost over a certain period, usually monthly. At the top is your revenue for the month. Then you subtract your cost of goods sold to get your gross margin, which is the amount of money available to pay all the bills included in your company’s overhead. Those bills go into the next section (expenses) and are subtracted from your gross margin to give you your final net income or loss.
The income statement is super important because so many people get caught up in thinking that revenue = profit. That’s obviously not true! There are a buttload of expenses that have to be deducted from your revenue before you get to your actual profit (or loss).
Cash Flow Statement – This report literally shows the lifeblood of your business – your cash flow! It shows the amount of money flowing in and out of your business via income and expenses. It’s different from the income statement because your income statement might show that you made $10,000 profit, but you really only have $3,000 cash since you invested a bunch of that money into inventory.
Ignoring this report means setting yourself up to run out of cash because you won’t have any idea what your bank account will say tomorrow. So make sure you generate and analyze your cash flow statement on a monthly basis at least.
Estimate the Value of Your Inventory
It might seem simple – “I bought $10,000 worth of inventory, so my inventory is worth $10,000.” But it’s actually a bit more complicated than that because inventory costs fluctuate. You might pay your manufacturer $4 for each of your doodads in January, but then the price goes up to $6 each when you re-order in February.
There are three main methods you can use to calculate the value of your inventory: FIFO (first in first out), LIFO (last in first out) and weighted average.
FIFO – In the FIFO method, you assume that the first items sold are the first items you purchased. Let’s say you buy 1,000 doodads at $4 each in January. Then in February you buy another 1,000 at $6 each. Over the course of the first quarter, you sell 1,500 doodads, leaving you with 500 unsold doodads. Since the February purchase was the last one “in,” you can safely assume that the 500 unsold doodads are from that group since everything from January was sold first. Here’s how to figure out your total inventory cost for the quarter.
1,000 doodads x $4 = $4,000 in January
500 doodads x $6 = $3,000 in February
$4,000 + $3,000 = $7,000 inventory cost
Your 500 unsold doodads are an asset since you still own them, so they don’t count towards your inventory cost for this quarter.
LIFO – LIFO is the same as FIFO, just reversed. So instead of assuming the 500 unsold doodads in the example above were from January (first in), you would assume they were from February (last in). Here’s how that would look using the same numbers:
500 doodads x $4 = $2,000 in January
1,000 doodads x $6 = $6,000 in February
$2,000 + $6,000 = $8,000 inventory cost
Your total comes out to be more using LIFO in this example, but in the end it all works out to be the same. Eventually you’ll sell all 2,000 doodads and the cost will balance out.
Weighted Average – With the weighted average method, you use the average cost of all your inventory units. So using our above numbers, you would first calculate the total value of your inventory.
1,000 doodads x $4 = $4,000 in January
1,000 doodads x $6 = $6,000 in February
To find the average, add those totals together and divide by the total number of doodads.
$4,000 + $6,000 = $10,000
$10,000 / 2,000 doodads = $5 each
Next, multiply $5 by the number of doodads sold.
$5 x 1,500 = $7,500 inventory cost
Deduct Inventory Losses
Everyone has inventory losses, whether they’re from theft, spoilage or an Amazon warehouse worker’s sticky fingers. Make sure you keep track of any unsellable inventory and deduct it from your inventory assets.
Holy shitsnacks! You’re literally an accountant now. You can totally go prepare people’s taxes and tell them what to do with their money just like a professional. Not really though.
But you can manage your own Shopify accounting and bookkeeping and actually know what you’re doing. Congrats on making next tax season utterly painless.
About the Author
Gennifer is the Marketing Manager at ByteStand, where she lives and breathes customer service education while sipping coffee in her pajamas.
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