It's a Business, Not a Unicorn

Do you know how much money you made yesterday? How about so far today? If you’re not sure or you’d like to get back to me at the beginning of next month after you’ve consulted your accountant, this article is for you.

Do you know how much money you made yesterday? How about so far today? If you’re not sure or you’d like to get back to me at the beginning of next month after you’ve consulted your accountant, this article is for you.

In the world of ecommerce, profitability can strangely feel like an afterthought. The mission of many VC-funded startups, as well as global behemoths like Amazon, is maximizing shareholder value, not profits. Their key metrics are clicks, conversions and market share. Profitability is a future concern. But you have to compete against them today; and the odds are that your company is not an aspiring Silicon Valley unicorn that enjoys the luxury of not worrying about short-term profitability. It’s a good old-fashioned business that needs to concern itself with such mundane matters as controlling operation costs, maintaining healthy margins and paying the bills every month.

When your competition is the Amazons of the world it’s no easy feat to turn a consistent profit. You need to be vigilant and you need to keep your finger on the pulse of your key performance indicators (KPIs). Timely, accurate and easily accessible business intelligence is a must to stay competitive. You need detailed reporting on each and every order to understand which sales strategies are working and which aren’t. Without this real-time feedback, you could be making all the wrong moves for weeks before you even realize there’s a problem. 

And even then, what exactly is the problem? Are the shipping costs on certain products simply too high to warrant selling them to distant destinations? Are those great margins you think you’re getting on marketplace sales actually being eaten by fees? Are there errors in your product data that are leading to inaccurate pricing? Without an accurate real-time gross profit reporting and analytics tool for every order, you may not know the answers until it’s too late.

The Multi-Channel Challenge

A lot of small-to-midsize companies suffer because they conclude that the burden of collecting, standardizing and processing all this data is simply too much of a drain on their limited resources. If these companies are multichannel sellers, the burden can increase exponentially. Order data is siloed in various formats in different marketplace accounts and ecommerce platforms. Shipping and fulfillment costs are housed in a separate shipping application. Product costs may be in still yet another system. And critical pieces to the ecommerce profit puzzle like marketplace fees, credit card fees and currency exchange fees are scattered amongst a slew of other accounts and systems. By the time these companies collect all this data and plug it into a user-friendly dashboard, precious time and money will have already been lost.  Many companies will simply throw their hands up at this point and opt to wait to calculate the company’s overall profitability only once all the invoices have been paid and the deposits are in the bank.

In the highly competitive and data-driven world of ecommerce this is hardly the optimum way to operate. It’s well worth the effort to create a gross profit reporting tool that gives you real-time, actionable data.

The Gross Profit Equation

Arriving at an accurate gross profit for every ecommerce order is a matter of subtracting all costs that can be attributed directly to a particular transaction from the total revenue. The math is simple; the data gathering can be hard. Costs include product, shipping, platform and marketplace transaction fees, credit card fees, currency conversion charges and allowances for refunds and returns. All other costs should fall under general operating expenses and be fairly consistent from month-to-month.

Whenever possible, it is imperative to collect the actual data in real time. The increasing availability of APIs has made this a more viable option in recent years. But inevitably getting fast, actionable results does require a certain amount of projection and estimation. Costs such as shipping charges, transaction fees and refunds and returns are either not incurred at the time of the sale or unavailable until days or weeks afterwards. 

Herein lies the rub. You need accurate feedback on gross profits and margins now… right now. That run on widgets you’re getting from having captured the Amazon Buy Box – are you making a profit on each of those orders? Is it sustainable? Can you hold on to the Buy Box and still hit your target margins? All critically time-sensitive questions if every order out the door is actually losing money. But the data simply isn’t available yet to give you the answers. And relying on outdated or unconfirmed estimates can be a slow road to hell (if your idea of hell is your bank deposits falling short of your accounts receivable balance). 

The solution is to utilize estimates backed by monthly reconciliation against third-party statements. It’s the only way to ensure that those real-time KPIs that you are relying on are on point. Let’s walk through a quick example of how to do this effectively. 

Case Study - Gross Profit Per Order

Let’s say you are a U.S. seller who sells on a foreign sales channel like Amazon France and your average order value (AOV) is €50,00. Off the bat it’s going to cost you to get those Euros converted to USD. Amazon typically takes about 3% off the top for currency conversion.

Amazon owes you $44.52 USD for the order. Then you need to account for the product cost of goods sold and the cost to ship the product to the customer:

Your proceeds are now at $12.52. Refunds and returns are a big part of ecommerce as well. You’ll need to make a general estimate of the per order percentage of revenue you lose to refunds and returns as the actual losses are often not realized for weeks or even months after the sale. If you sell apparel like shoes, customers may even return one or two pairs for every pair they keep. But in most sectors you are looking at an average of about 2-5% of revenue being lost due to refunds and returns. In our example we’ll assume you run a tight operation and estimate your refunds and returns allowance at 2%:

This leaves you with a gross profit of $11.44 and a gross profit margin of 21.2%. Some sellers may choose to add additional costs like advertising into the equation. If you choose to do so, it’s important to be able to arrive at a cost-per-conversion relevant to the SKU being sold. This could be challenging depending upon how your advertising service handles its billing and how you structure your campaigns. The other (albeit less precise) alternative is to simply divide your entire monthly advertising budget for a given channel by the average number of total orders per month and apply that amount to the costs for each order. 

Making Sure You Have It Right: Monthly Accounts Receivable Reconciliation

In a world where data is king, but not always as available or as easily accessible as we need it to be, we are forced at times to use some reliable estimates. Many ecommerce companies are accustomed to recording revenue until the payment processor has deposited cash in the bank. But for those who sell Amazon, this can mean waiting for up to two weeks after an order is placed to record revenue and calculate profit, far too long to be considered timely and actionable. Sellers need to be recording revenue and calculating gross profit for each order at the time it is placed. This is keeping with the best practices the accrual method of accounting and most of the rest of the business world: recording revenue and payments as they happen and tracking unpaid amounts in accounts receivable. 

In this practice, reconciling the seller’s month-end accounts receivable balance is imperative to ensure that any estimates the seller is relying upon for daily dashboards and gross profit reports are accurate. This involves reconciling your accounts receivable balance (sales revenue at the time the order is placed less payments by the third party from which the funds are due) with what third parties such as Amazon, Shopify, PayPal, etc. stipulate they owe the seller at the end of each month. The seller’s end of month accounts receivable balance is then adjusted to agree with each third party’s stated month-end balance.  

Amazon complicates this task by not providing the seller with an accounts receivable balance at the end of each month. Some of the leading industry solutions have adapted to this obstacle by simply delaying their revenue recording and accounting until Amazon issues a settlement report about every 14 days. They then reconcile the Amazon settlement statement against the revenue from orders placed. This approach may work for some sellers but it has significant drawbacks. Chief among them is the delay in recording revenue and getting the third party confirmation data you need to ensure your gross profit results are accurate. It also creates additional work for sellers performing proper monthly accrual method accounting and calculating a monthly accounts receivable balance. The example below illustrates how to solve this problem in a manner that satisfies the need for both accurate gross profit-per order reporting and sound bookkeeping.

Case Study: Amazon Accounts Receivable Reconciliation

You can see that Amazon issues a settlement report every 14 days. It documents which orders have been paid for but it does not address fulfilled orders that remain unpaid. Sellers need to maintain their own record of all orders by date and track the amount disbursed by Amazon for each order according to the settlement report. 

The settlement report dates in this example are the 9th and 23rd of the month. When you add in the fact that Amazon typically does not settle any orders from the two to three days prior to the settlement date, there is the potential that you will reach the end of the month with ten days’ worth of unpaid orders. Fortunately, the Amazon Marketplace Web Services (MWS) API does provide the amount owed to the seller for fulfilled orders even if they have not yet appeared on a settlement report. 

By adding the amount disbursed by Amazon for paid orders and the amount owed for unpaid orders, you arrive at the full amount that is due the seller for all orders for the month. Subtract from the amount disbursed for orders appearing on the settlement reports from the 9th and the 23rd and you arrive at the elusive Amazon month-end accounts receivable balance. 

Amazon deducts seller fees, refunds and a currency conversion fee before depositing the seller’s portion of the proceeds in the seller’s bank account. In this instance, the seller expects to be paid in the amount of $20,223 by Amazon for all of the month’s orders. This is a debit to the accounts receivable accounts while the applicable payments from Amazon are a credit. This leaves us with an AR balance of $7,143 at the end of the month. 

With this balance in hand, you can now check the accuracy of your gross profit reporting, potentially weeks before all the month’s orders actually appear on a settlement report.

We reconcile this amount against the third party payer (Amazon) balance we calculated using the settlement reports and the Amazon MWS API. The reconciliation reveals a difference of -$595 which amounts to 2.5% of total revenue. The seller has underestimated his fees by 2.5%, perhaps because he failed to account for some refunds or did not account for the Amazon currency conversion charge.

To complete the books, the seller makes a journal entry crediting the accounts receivable in the amount of $595. The gross profit reporting for the prior month and the upcoming month is adjusted to deduct 17.5% in fees from every order. The process is then completed on a monthly basis. Before long, the fee adjustment will amount to little or nothing. The seller will have nailed his receivables and confirmed the accuracy of his daily gross profit reporting.  

The Upshot: Actionable Insights into Your Business

Knowing your margins and gross profit per order in real time is critical to managing your ecommerce business responsibly as well as quickly identifying new opportunities for growth and expansion. If you are waiting for monthly reporting to understand your company’s financial performance you are losing out on precious time, money and intelligence.  You need a solution that provides this data in real time for every order on every sales channel, arming you with the business intelligence necessary to survive in the highly competitive world of ecommerce.

Margins are notoriously thin in ecommerce and growing thinner as competition increases and Amazon’s dominance continues unabated. You can compete in this environment but it takes vigilance and constant attention to your key performance indicators. Otherwise, you could find yourself forever chasing the unicorns and waving goodbye to profitability.

Hitting Your Target Margins and Avoiding the Deficient Orders Trap

Ecommerce companies should be very intentional about their margins - not just taking whatever they can get. A lack of daily attention to margins can lead to things spinning out of control and profits suffering in the name of simply keeping the orders rolling in. This requires a tool that allows users to set their target margins and then identify which orders are falling short, a circumstance which can happen for any number of reasons. Two of the most common are bad data and succumbing to the temptation to chase unicorns.

Product Date: Garbage In, Garbage Out

If you’ve been around ecommerce long enough you may know that large volume sales days are not always good news. Innovative supply chain management strategies like just-in-time fulfillment, dropshipping and Fulfillment by Amazon (FBA) allow for today’s ecommerce merchants to sell a large variety of products without ever handling the inventory.  This relieves the merchant of having to deal with the many challenges of supply chain management, warehouse management and fulfillment but creates a huge data management challenge. If you’ve received bad data (or no data) from your supplier or something went wrong with importing it to your system, you could be pricing your products incorrectly. If you are too low you might not only be missing your target margins but actually losing money on every order. You’d have fared better if you never got out of bed.

Daily tracking of your sales and margins is critical to ensure that you are hitting your target margins. If something seems too good to be true, it’s worth digging into your data to make sure that isn’t, in fact, the case. On the flip side, if a product is not moving as expected it may be priced artificially high. Correcting the error could mean a meaningful uptick in orders and profit.

Chasing Unicorns: Winning the Buy Box but Losing the Farm

Another common pitfall is succumbing to the siren song of order volume. Businesses have a natural inclination to stay busy and keep moving product. In the world of ecommerce you can boost your traffic and your conversions with a simple price reduction. Offering free shipping can also easily help you win over more customers. The danger is mistaking this growth for progress.

Marketplaces that allow algorithmic repricing offer an automated assist in the race to the bottom. If you are not careful with where you set your floor you could find yourself winning the Buy Box but losing the farm. You need to carefully monitor your sales to ensure you are remaining faithful to your target margins. Every pricing decision should be tested by comparing custom time periods to one another to see which pricing strategy was most effective at maximizing margins and gross profit. Don’t test in the dark; monitor daily or even hourly to see how the market is responding to your changes.

Again, if a sudden unexplained surge in sales of a particular SKU seems too good to be true, it probably is. Early notification from your business intelligence dashboard will give you the heads up to fix your pricing before it’s too late and you’re stuck filling tons of orders at a loss.

Identify Trends and Opportunities

Rest assured, daily gross profit monitoring is not just about loss prevention. If your data and your margins do check out then you might be onto something! Whether it be a particular product, promotion or growing trend, you want to strike while the iron is hot and capitalize on what’s working. But you need the intelligence you get from order-level detail in order to know the best move to make. 

This is where fast feedback on which products, brands or categories are moving, and on which sales channels, is critical. Your task is to push the winners and dump the losers. Develop hypotheses on which products have enough margin to support an increase in the ad budget; whether to exclude heavy items from your free shipping offer; or whether your higher value products could withstand a price reduction to drive more sales; and then test the impact these moves have on your margins and your gross profit. 

Don’t make changes in the dark and simply hope that the monthly financials will indicate that they worked out for the best. Monitor your changes on a daily or even hourly basis to see how the market is responding and what the ultimate impact is on your bottom line.

The data is all out there. It’s your data and it has a story to tell about your business. MarginDriver has brought it together to give you the answers and actionable insights you need to succeed in today’s environment. 

You’re not a unicorn. You’re a business. Know your numbers.

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MarginDriver White Paper

Despite the emergence of ecommerce as insurgent force in an otherwise mature retail industry, none of the existing accounting systems were designed to handle the complex flow of financial data or provide order-level profitability reporting and analytics for all multichannel transactions. Enter MarginDriver - a sophisticated, user-friendly cloud application that provides the speed, functionality and universal access needed for internet sellers to thrive in today’s competitive ecommerce market.

December 6, 2022