Many Amazon sellers often start as small hobby businesses and enjoy the ease of the cash method of accounting. The cash method is a simple approach that is similar to how you manage your personal finances. When you receive money from a sale, it is considered income and when you pay for a supply or service and the business cashes your check, you have an expense. You can easily understand your cash flow. The IRS allows small businesses to operate using a cash method until the business has annual revenue of $10 Million; unless they have inventory. Other stipulations may apply, so see: https://www.irs.gov/publications/p334/ch02.html and always consult a tax professional.
Since Amazon businesses have inventory, many automatically set up to use an accrual accounting methodology. This is a more complicated method as it requires the business to record its revenues when the sale occurs, not when the cash is received. This requires a two-step entry into the books:
At the time of the sale, there is an entry to show the revenue on the Profit and Loss and the amount owed as a receivable on the Balance Sheet.
At the time the payment for the good (cash) is received, there is an entry to record the cash and deduct the amount of the receivable.
A similar set of steps is required for expenses using an Accounts Payable account on the Balance Sheet.
For many Amazon Sellers, the revenue and expenses are incurred and transacted through cash in a relatively short time span. Using an accrual method doesn’t provide any better understanding of the financial standing of the business. It does add additional steps and time to manage accounting tasks. However, understanding the longer term impact of our Inventory purchases and sales on financial performance is a useful application of the accrual method.
By using the modified cash method, you blend benefits from both worlds. You can simplify your typical short term income and expense transactions and process them using the cash method. The longer term transactions such as inventory purchases, are treated as an accrual type transaction.
To use modified cash for inventory, inventory is recorded as an Asset when it is purchased. At month end, you reduce this account by doing a Journal Entry to Inventory and Cost of Goods Sold. This gets the value of what you sold onto your Profit and Loss report and removes the Inventory sold from your Inventory account on the Balance Sheet. InventoryLab makes it easy by pulling the report that lists ending inventory.
Using this method, you can see how profitable you were on the sales you made during the month without significantly increasing your accounting tasks. As with any change that may affect your tax status, consult with your accounting professional to determine if this methodology is a good solution for your business.