Ecommerce gross margin should be one of the most useful numbers in your financial statements. It tells you how much money is left after accounting for the cost of the products you sold.
The problem is that the number is only useful if it is right.
We see ecommerce businesses with growing sales and what appears to be a healthy gross margin. But once we start looking at inventory, landed cost and cost of goods sold, the picture can change.
Sometimes quite a bit.
Start With the Right Product Cost
Assume you buy a product from your supplier for $20 and sell it for $50.
It looks like you made $30.
But did the product really cost you $20?
Maybe you paid another $3 for freight. Add tariffs, customs duties and other costs necessary to get the product ready for sale, and your actual cost might be $26.
Now your gross profit isn’t $30. It’s $24.
That difference gets pretty important when you sell thousands of units.
This is why we spend time determining the proper landed cost of inventory for our ecommerce clients.
Inventory and Cost of Goods Sold Have to Work Together
You cannot get gross margin right if your inventory is wrong.
If you purchase $100,000 of inventory, that does not mean you had $100,000 of cost of goods sold.
You still own whatever you haven’t sold.
This sounds obvious, but ecommerce inventory moves constantly. Products can be sitting in your warehouse, at Amazon, with a third-party fulfillment company or somewhere between your supplier and the United States.
The accounting still has to capture what you own.
Otherwise, cost of goods sold can be wrong before you even start calculating gross margin.
Timing Can Make a Good Month Look Bad
Ecommerce businesses can have big swings in purchasing.
You might purchase $200,000 of inventory one month because you are preparing for the holiday season. That does not mean the entire $200,000 belongs on that month’s income statement.
The cost needs to follow the products being sold.
If purchases are treated as an expense when they happen, one month can look terrible while another looks unusually profitable.
Neither month is telling you what actually happened.
We want monthly financial statements that allow an owner to compare one month to another and see something meaningful.
Returns Can Change the Picture
Returns create another problem.
You made the sale. You recorded the revenue and cost of goods sold. Then the customer sends the product back.
Now the sale may need to be reversed. But what happened to the product?
If it can be sold again, it may belong back in inventory. If it is damaged or lost, it may not.
There may also be payment processing fees, return shipping and other costs that you never recover.
A product with a high return rate can look much better when you only look at sales.
Don’t Put Every Ecommerce Fee in Cost of Goods Sold
Another common problem is deciding what belongs in gross margin.
Amazon fees, Shopify fees, payment processing fees, advertising, fulfillment costs and shipping costs all affect profitability.
That doesn’t mean they all belong in cost of goods sold.
Consistency matters.
If you put payment processing fees in cost of goods sold one month and operating expenses the next, your gross margin percentage moves even though nothing actually changed with the business.
We want the financial statements set up the same way every month.
Then changes in gross margin actually mean something.
Look at Margin by Product and Sales Channel
A company-wide gross margin is a good starting point.
It shouldn’t always be the ending point.
You may have one product with an excellent margin and another that barely makes money. Amazon may produce a different margin than Shopify.
That information becomes even more useful when advertising enters the picture.
A product can generate a lot of revenue and still not make much money.
We would rather know that before you spend another $100,000 advertising it.
Gross Margin Should Help You Run the Business
We don’t calculate ecommerce gross margin simply because it belongs on an income statement.
It should help you make decisions.
Should you raise a price? Is freight eating into the margin on a product? Did a new tariff change the economics of a SKU? Is one sales channel producing a better result than another?
Those are business questions.
Your accounting should help answer them.
At Schultz & Associates, CPA, we work with ecommerce businesses to produce accurate and timely monthly financial statements. That includes properly accounting for inventory, cost of goods sold, landed costs, returns and the other activity that affects gross margin.
Sales are important.
But knowing what you actually made on those sales is a lot more useful.