7 essential eCommerce Accounting KPIs that help online sellers make more money
As an eCommerce seller, there's always pressure to sell more. Offer more products. Run more ads. Grow your revenue. More, more, more. But, the "sell more" mentality may be destroying your eCommerce business.
What are the 7 essential KPIs for eCommerce accounting?
If you aren't tracking the right numbers to guarantee every sale is profitable, you could be selling yourself into a hole you can't get out of and piling debt on top of it all. These numbers indicate what's really going on beneath the surface of your eCommerce business, which is why they're called Key Performance Indicators (or KPIs for short). KPIs vary by industry, but some of the most critical KPIs in eCommerce include:
Overall profit margin
Contribution margin by product line
Ad spend as a percentage of sales
Marketing ROI
Debt ratio
Inventory turnover rate
Customer lifetime value (CLV)
Let's take a closer look at each of these KPIs to see what they reveal and how you can use them to improve your online store's profitability and make more money.
Overall Profit Margin
The rawest and most basic view of your eCommerce business's profitability is the gross profit margin. Put simply; this is your sales revenue minus the direct cost that went into the products you sold. Those direct costs can be bundled together as Cost of Good Sold.
Gross margin can be measured on many levels, but for now, we're only talking about the gross profit margin of your business as a whole. As glamorous as it sounds to sell more, your real goal is to end up with money in your pocket, right?
So, what would be considered an excellent gross margin in eCommerce?
Shopify cites 45% as a good margin for online retail.
Of course, this will vary depending on what you're selling, but keep in mind that the lower your margin, the more you have to sell to cover your overhead expenses.
If your overall gross profit margin is too low, that's a key indicator that something is wrong, and you're not walking away with much money at the end of the day. That means your gross margin needs to be big enough to cover selling expenses, administrative expenses, marketing expenses, etc. and leave enough for you after the government takes his cut.
Contribution Margin by Product Line
Now we're taking things down a level to look at individual product lines. Assuming you sell more than one product, the next step in proper eCommerce accounting is to look at which products are helping and which products are hurting. Studies have shown that most businesses have a few product lines that make most of the profit, several that make almost nothing, and a few freeloaders that lose money but get covered up by the winners.
The contribution margin looks at how much is left from each unit sold after covering the variable costs for that unit (COGS for the unit). You can look at the contribution margin as a percentage or as a dollar amount. Either way, it represents what each sale "contributes" toward your overhead expenses, taxes, and profits.
Selling more of a losing product will actually decrease your gross margin and could put you out of business. Selling a lot of mediocre products won't add much to your profits, but it forces you to work harder and spend more in overhead (think big warehouses full of products that only break even). Knowing your contribution margins lets you focus your efforts on the best products and cut the ones that are damaging your eCommerce business.
Bottom line: once you have full visibility on your contribution margins, you can significantly improve your eCommerce business by merely dropping your lowest-performing products and replacing them with higher-margin offerings.
Ad Spend as a Percentage of Sales
Many online business owners look at numbers out of context. Looking at your ad spend on its own doesn't give you much useful information. An experienced eCommerce accountant will recommend looking at ad spend as a percentage of sales to see how the numbers relate to each other.
Now, you may be expecting us to tell you to cut all your expenses. Slash that ad spend down to a skeleton and pinch your pennies. Many of the eCommerce businesses we've worked with have too low of a percentage of sales committed to ad spend. As long as the marketing is profitable and effective, ad spend is more like an investment than an expense. Investing too little in your advertising slows the growth and makes it hard to scale your business to the next level.
Another way to look at your ad spending is to track ROAS (return on ad spend). ROAS is calculated by taking the revenue brought in by an ad and dividing it by the money spent on the ad. The Corporate Finance Institute considers a ROAS of 3 a good baseline for eCommerce. For instance, $50,000 in ad spend generating $150,000 in revenue would be a ROAS of 3. Of course, this depends on your margins. Since ROAS is measured by revenue and not profit, some businesses will need to see a better ROAS than others or end up losing money after they cover their costs.
Marketing ROI
So, how do you know if your marketing is a good investment? Track your marketing ROI by channel. Marketing is more than just ads; it's email campaigns, social campaigns, blogging, and more. Shopify reports, for example, show the source of your traffic, whether that's search, an email link, or a social media platform. You can use that information to determine how much of a return you get on each marketing dollar.
The basic formula to calculate ROI is sales generated by the marketing effort/cost of the marketing. Generally, any time you spend a dollar and bring in more than a dollar in return, that's a good thing. But keep in mind that it's all dependent on your profit margins. If you spend $1 on marketing, generate $2 in sales, then turn around and spend $1.50 on COGS, you're losing money. But now that you're tracking contribution margins, you can factor those into the equation. Multiply your sales by the contribution margin percentage first, so your ROI is based on profits rather than revenue.
By focusing on the most profitable marketing channels, you can ensure that you make a profit from your marketing efforts. If every ad, email, or social campaign is putting profits in your pocket, it's a natural choice to increase your ad spend. This is the quickest way to scale your eCommerce business.
Debt Ratios
Starting an online store is often pitched as the perfect way to go into business without spending a bunch of money. But many online sellers seek out cash to help them scale their business up or even to purchase inventory to get started. How much money you raise and how you raise it can make a big difference to your outcome.
You can raise capital for your eCommerce business through either debt (taking out a loan) or equity (selling part ownership in your company). Both have their pros and cons. Equity, for instance, gives permanent ownership of part of the company (and portion of the profits) to someone else. Debt, on the other hand, only lasts until the loan is paid off. However, if you have a rough year, you'll be required to make your loan payments on the debt, whereas the equity owner has no minimum payment and only shares in the profits if they exist.
Debt is often the easiest to get, leading many online sellers to take on high-interest debt from Amazon Loans, Kabbage, and others. If you're considering debt, you need to pay attention to your debt ratios and make sure it's beneficial. There are several ways to measure these ratios, typically comparing your debt to your total assets, your equity, or your EBITDA (a calculation similar to your annual gross profit). Debt ratios help you compare your business to the industry, evaluate if you'll be able to pay it back while remaining profitable and determine how it may impact your creditworthiness.
If you're looking into debt or equity options, consider working with an outsourced eCommerce accounting team to help you decide on the best way to raise capital. It's a big decision that takes some detailed analysis to get right. And getting it wrong can be seriously expensive.
If your eCommerce business has stable sales, your accountant can also help you produce financial statements needed for bank financing. A line of credit from a local bank often carries a much lower interest rate than the online programs we mentioned earlier. This makes it much easier to make a wise financing decision where you know each dollar of debt will produce enough income to make it profitable.
Inventory Turnover Rate
Inventory is one of the most significant expenses for many eCommerce businesses. Striking just the right balance can have a substantial impact on your cash flow. Too little stock, and you'll be out-of-stock and miss out on sales. Too much inventory and you are typing up your cash in excess products that you don't need. This can also lead to the need for clearance sales and discounts to get rid of inventory that becomes damaged, expires, or simply goes out of style on your shelves.
The inventory turnover rate is a measure of how many times your average inventory sells in a year. You can find it by dividing the cost of goods sold by your average inventory amount (in dollars) for the period. If you have too much or too little inventory, your sales and orders aren't in sync.
Bonus tip: Are you struggling to track your inventory value? Many eCommerce sellers are because most accounting software isn't designed for eCommerce. If you simply import the data dump of information from Amazon or Shopify into QuickBooks or Xero, you'll have tons of information you don't need and no clarity on what's really going on. Proper eCommerce accounting demands a better breakdown of sales numbers, without all the mess of data you don't need to track.
The best way to achieve this is through an app like A2X. This tool is designed to take data from your sales channels, sort out what you need to know, and get it into your accounting software the right way. You'll be left with more insights into your inventory management so you can maximize your profitability.
Customer Lifetime Value (CLV)
Whether you're in eCommerce or any other industry, there's nothing quite like a repeat customer. Loyal customers help you grow your revenue without increasing acquisition costs like marketing. And pretty soon, they start bringing their friends and family along with them.
Measuring the historic lifetime value of a customer is relatively simple. All you have to do is add up the total gross profit from that customer over their "lifetime" as a customer. It gets trickier (and much more useful) to predict customer lifetime value moving forward. By factoring in average order value (AOV), average gross margin, and the average number of months customers buy from you, you can create a prediction of CLV. This is a terrific baseline to determine how much a customer is worth to your business and what you should be willing to spend to attract a new one.
The Wrap Up
As you can see, just "selling more" isn't always beneficial. You need insight from your accounting system to help you decide what to sell and how to sell it for maximum profits. A few tweaks, and you could be putting more in your pockets each month without working any harder.
If crunching those numbers isn't your idea of a good time, reach out and partner with an outsourced accounting firm who understands eCommerce accounting.
