We’ve got a quick but extensive accounting lesson for you today from Catching Clouds co-founder Scott Scharf. As an eCommerce accounting expert, Scott gets to see the inner workings of dozens of eCommerce businesses — and he’s here to tell us what separates the good from the great and offers up his best eCommerce accounting tips.
We tackle a lot of topics including automating your business (so you can work less), the minimum gross margin you should shoot for, and cash vs. accrual accounting. Scott also talks about his favorite apps for optimizing your accounting processes and making your business run better.
Andrew: Welcome to the eCommerceFuel Podcast, the show dedicated to helping high six and seven-figure entrepreneurs build amazing online companies and incredible lives. I’m your host and fellow e-commerce entrepreneur, Andrew Youderian.
Hey, guys, it’s Andrew here and welcome to the eCommerceFuel Podcast. Thanks so much for tuning in. Today on the show I’m joined by Scott Scharf from Catching Clouds. It’s his e-commerce accounting and bookkeeping firm. He works with successful, you know, seven-figure-plus e-commerce store owners to help them with their accounting and make it less of a nightmare, as it sometimes could be.
We don’t just talk about the basics of accounting, we talk about things like how does sales tax in Amazon work. I asked him what he’s able to see with a very unique perspective of seeing into all these different books and financial statements of eCommerce companies, where are some of the commonalities? What does he see with businesses that are really doing well?
We talk candidly about…that you have to keep receipts. It drives me crazy having to keep all those little receipts, because that’s something… When you go out to dinner or a business meal or small expenditures traveling, is that something actually you have to do and downside if you don’t? We definitely get the accounting side, but a lot of kind of high level what I think are interesting topics that we cover. So hope you enjoy it. We’ll go ahead and dive into discussion with Scott from Catching Clouds.
Scott, I remember three years ago when I first saw Xero, I was blown away. It was SaaS, it was hosted in the cloud for accounting. The auto taking rules were so much better than the QuickBooks I have been coming from, on my Mac platform. I was really impressed. But that was three years ago. Is Xero still the top dog? I know QuickBooks has been kind of promoting their online version of their software. How does QuickBooks and Xero and specifically Stackup kind of today?
Scott: That’s great. We have been Xero for four-plus years, and the fundamentals that made it better than anybody else are still there. In our opinion, and we’re very Xero biased as we run our business and trust our business and our client’s businesses too, Xero, it’s great. Intuit, because of Xero, has been doing me too features and it’s fairly close on par at the moment. So they are actually fairly close together. I still believe Xero is a better product. I think it’s easier to use, it’s cleaner. I think they have a stronger marketplace. Intuit can throw more money at things.
Andrew: And Intuit is the company behind QuickBooks, right?
Scott: Intuit is the company behind QuickBooks and really QuickBooks online. And everybody that’s not in a cloud app, if you’re an online or e-commerce business, you wanna move to a cloud platform. But what you’re gonna start seeing now that Xero just migrated over to Amazon Web Services is they’re gonna start pulling ahead again of Intuit from advanced machine learning and some other automation that’s just gonna make accounting that much better.
We’ve written blogs about how bookkeeping is gonna go away as a profession because computers are gonna take over and automate a lot of those functions. If you are unhappy at all with QuickBooks desktop or QuickBooks online or you don’t have anything now, Xero is just a much better, an easier place to start, you know, from an accounting platform. As a business owner non-accountant, my partner is an accountant.
Andrew: Yeah, that’s amazing. Just going from a desktop-base solution to a cloud-based solution was a game changer for me. It’s so much easier to have other people collaborate with you and getting stuff that your accounting. It made things a lot easier. One thing that I’m really jealous of, that you have is this incredible kind of X-ray vision into people’s businesses.
Whenever I go to my bank, like, for anything and I’m sitting down with the bank, I always ask them, “Hey, what…?” They have the same kind of perspective that’s a few of us have and ask them, “What do you see? Like, do you see any commonalities or what kind of business are doing well?”
And I would like to get your perspective on that, especially with such a niche focused on e-commerce, what do you see…? and obviously you have to protect confidentiality, but do you see any general commonalities, and particularly with businesses, not necessarily that are big and they drive a lot of revenue, but that are really profitable? Is it smaller nimble teams that minimize or have to do really well? Is it manufacturers of original brands that are defensible workaholics that spend, you know, 120 hours per week? Do you see any commonalities?
Scott: I do. I mean, some of them, it’s that the first two things is a mindset, and that’s that willingness to take a risk. Not crazy, life-threatening risks, and that is that’s ability to adapt to the fact that e-commerce not only is new but is changing on a daily, weekly, monthly basis. Those are some of the kind of the first mindsets and those same people are looking at always learning, okay?
Anything they learn about, whether it’s specifically a business or a new way to do things on Amazon or wherever else, so those are the mindsets. We don’t ever think and I don’t think our… We have a few clients that work some crazy hours, and that’s what we are trying to avoid, is, how can you automate your business and you, can especially without sourcing your fulfillment, you’re not shipping all the day everything over the Amazon?
About the different things, the biggest thing I would say that people keep an eye on is that they pay attention to their finances. They keep an eye on their overhead but they really look at the margin per skew, okay, and that they know that the bulk of their products and that they are trying to drive those margins so that their business is throwing off enough profit and cash on a consistent basis.
So they have both the velocity of the sale or the product which they are keeping an eye on. They’ve got enough margin. So when they know they’ve got that investment, that it freeze up that cash so that they have the flexibility to either buy more of that product that’s selling quickly and better and moving forward.
Well, we have clients that are brands. We have a client that’s doing retail overcharge that’s killing it, like doing amazing and making great profit. It’s a hell of a lot of work, okay, on their part and their accounting part. It’s that focus of what your mission is and what you’re trying to do with a little bit of an eye out to the killer asteroid. Is Amazon going to suspend you? Or, is a whole bunch of competition gonna come in? Are you either super solid in that niche and that you know that you can maintain it for a while or that you’re diversifying across different products?
It’s kind of a cycle. I’d say that the successful things is the people that work in their business a bit but take enough time outside of their business to really look at the overall e-commerce market and look at the what things are changing, as well as to strategize and just get away from the business enough. That if you haven’t done those things, you can’t come in and you just can’t throw yourself in 100 hours a week and just be in the weeds all the time. You’ve got to come out of the weeds.
And those are the things. It’s not so much brand versus a specific product or private label versus this. All of those things are constantly changing. It’s really the business owner’s ability to both work on the details and then take a higher, bigger picture view, and then go from there.
Andrew: You mentioned margins. What do you see as kind of a minimum overall, let’s say, gross margin for a product if you had to categorize, like, between your e-commerce stores that do really well and don’t? Is there a threshold that you can say where this is really where you should be your bottom line if you are thinking about getting into a new business?
Scott: I’m always analyzing that and looking anything else. I can tell you, I don’t like it anything below 30%. Some people go, “Oh my god.” If you’re working anything below 20%, you’re working really, really hard, and that’s a blended rate. Now, if you have a few products that are much higher margin and are less work and are generating extra cash, or you have some lower margins ones that are just so rock solid and take a little effort to run, then you can have some smaller margins.
But the idea is to continue to identify those products that, in my opinion, have a 30% plus margin, because it just doesn’t matter how lean you are. Because if you are super lean, you are throwing a bunch of time. You’re just giving up time, it’s time and money. That’s very generalized. I’d like to see margins over 50%. The businesses that we see that are over 50% and up to 100% margin on their products after, and we’re talking a landed cost, after customs and shipping and everything else, and they’re aware of those things. They just have so much more flexibility as a business. They have more cash to do the things they need to, whether it’s personally or in the business.
Andrew: I would love to get your take on cash versus accrual accounting. I think this is something that is a big decision and advertise a lot of people up. Cash for people that may not be familiar, if you are doing cash accounting, you record everything as it comes in. So you don’t try to adjust for when sales were made. You just really look it as cash flow basis and that’s how you build your P&L or your profit and loss statement.
When you are doing accrual, you try to adjust those cash flows for when they come in. So if you create a sale, let’s say, in June but don’t get paid till September, even though you get paid, you account for that sale in June because that is when you generated it. Cash is easier not as accurate, accrual is more complex but gives a better accurate picture in most cases of the business. Scott, how does a company decide which one to do and when did the benefits of accrual make up for all the additional headache that goes into doing it?
Scott: Well, the most important thing is to be able to look at your financials and understand what they are telling you as a story so you can make great decisions, okay? And in our case, we think and we’ve moved most of our clients to accrual, but there are quite a few cash reports that you look at.
So, cash versus accrual, accrual gives you a better understanding and overview of how the business is doing overall and it’s a really good way to look at your business. And then once you’re over $1 million, you’re pretty much required, or it’s recommended or highly recommended and I recommend it, that you switch to accrual basis. Now, keep in mind the switch to accrual, when you either file an extension or you file your return, you actually have to have your CPA fill out a form and request to be accrual because it’s how you file your taxes, okay?
Andrew: Scott, sorry to interrupt, but when you say it’s required, is there an IRS requirement at $1 million in revenue to start using?
Scott: It is. Yes, there’s a requirement, but you do have to ask. You can wait but it does say… And at some point in time, two million, three million, at some point in time the IRS will see that you’re over that amount and send you a note that says, “You’re now required to file in an accrual basis.” Okay?
So it’s a tax filling piece and it helps. I mean, it takes things, like, i you’re paying 12 grand for a product liability insurance, you pay $12,000 in cash in January, but then the accrual takes that and spreads it out into $1,000 payments throughout the year to show you how money is being spread across your business, okay, how your expenses spread, versus, “Oh my god, I pay all these annual bills in June, and look, June, it’s awful.”
So it allows you to kind of look at your business as a whole year when you’re in accrual, but cash is important for understanding cash flow and looking at things. What we do and what’s awesome about Xero, again, is that you can be doing all of your accounting, and there are extra accounting rules that you have to follow in Xero, but you can flip and look at the reports in a cash basis, okay?
So, as an owner, whether you think about it where, “I want to look at it from an accrual basis on how it spreads out over a year,” or, “I want to see where I am from a cash basis,” you can look at both. It’s really more of…and I always look at the accounting. You want your accounting as accurate as possible, so it’s a tool for your day-to-day to make great business decisions. It is not totally meant. It is important once a year to file your taxes or to take your finances and get a loan, but for the most important thing is to look at it.
And whatever makes the most sense to you as an owner to look at the reports, to understand what’s really going on in your business that day, that week, that’s how you should look at your business. But it is worth the additional effort to have either yourself or an accountant or a bookkeeper to keep your books in an accrual basis, because it’s just another way to look at your business and it just gives you different insight.
Andrew: But one thing I’ve always wondered about is receipts. And I have a friend who…they don’t have a whole lot of cash or petty receipts. Most of it is on a credit card for their e-commerce business, but when they do travel they don’t keep paper receipts. If they get an Uber, if they go out to eat, it’s a fairly immaterial percentage of their business. But they just figure, “Hey, I’ve got it on a credit card, it is legitimate business, and I’m not gonna hassle with it.” Any thoughts on this? Like, do you need to meticulously keep track of all these little bits of paper if you keep them on a credit card? And if not, what’s the downside if you get audited?
Scott: Well, the whole reason and all the extra busy work, all the busy work that the government creates for us is, it really only matters if you get audited, okay? Because what they can come through and look at all of that business travel, it might be to ECF Live or something else, and they’ll look at that and disallow it, okay? So the reason you have all these business expenses is it reduces your overall profitability and the overall amount you need to…that you pay in taxes, okay?
So you’ve your income, you’ve got cost to good sold, then you have all these business expenses that reduce your profitability. So it really only matters at the end, but you do wanna capture some of this information, and you can use awesome tools like Expensify that now integrates with Uber and will capture all those and help you capture with a minimal amount of work all those little bits of piece of paper.
But you can decide, if it’s under $25 you don’t care, but if you have a thousand of those in a year and you don’t realize it and you get audited, they might disallow all of those little payments, okay? Because you don’t have the business use, you don’t have it linked, and they will just disallow it, and all of a sudden you owe tax on those things if you can’t prove it.
Andrew: So worst case scenario would be let’s say you have $5,000 in travel and meals throughout the year, worst case scenario is they say, “Hey, you don’t have as much documentation as we would like for this. You’re gonna have to pay, let’s say, you know, 25% tax.” You’re looking at a 12.50 additional tax that you have to pay on that just for that year.
Scott: Correct, that’s exactly it. So it’s really only at that point. So at the same time, you don’t wanna annoy the hell out yourself or waste your own time, we’re all busy running businesses. Or, just grab a pile and scan them all in and just keep them. You don’t even have to organize them or attach them to all the transactions in Xero, but you do wanna have all of that business information.
The other thing not just for the IRS. Keep in mind that you need to be able to understand exactly what’s going on in your business. If you’re going to sell it, you need to prove these things and say, “Oh yeah, this is really where things were.”
Andrew: That’s a good segue into talking about sales tax in Amazon, another maybe in murky area. So I think a lot of people, there’s some confusion about, if you have inventory at Amazon, in one of their fulfillment warehouses, does that give you nexus in that state? How do you advise clients, both on the letter of the law and also kind of the spirit of the law? What should people do? Do people need to be filing taxes in 20 different states for sales tax if they just use FBA? Because that seems crazy.
Scott: So, from the law, the answer is yes. If you send an over 100 widgets to Amazon FBA, whether it’s one warehouse or three, Amazon will end up moving them and storing your inventory in up to 20-plus states at the moment. And all of those states have really tuned up all of their laws to save your storing inventory or have employees or own property, which the inventory is, okay? You also can have some sales activities and a few other things. There is a lot of craziness around there. I have challenged TaxJar, Taxify, Vertex, and Avalara to say, “Is this disappearance certainly in doubt? Show me the laws that prove that you should have this whole market and you should be selling these tools to everybody.” So it really is the law.
The way I advise my clients and anybody I talk to is a risk management decision for your business. You should be aware of it, that the laws are out there, and is the risk of not collecting and filling and building this liability against your business worth the risk and the cost of being audited? Okay? Which is extremely low today, but will continue to go up, okay? In general, it’s gonna cost most people either in time, tools, and effort about $50 to $100 per state to collect the tax, do the filling, and manage it. It really does.
So whether it’s your time and you are looking at it or you are using a tool and you’re paying for tools that’s gonna cost it. So if you’re gonna owe Kansas less than $200 for the whole year, but if you owe $20,000 or more to California and the big states, California, Texas, Florida, and some of these other states, you might look at registering there sooner or later so that liability doesn’t grow, okay? Because it doesn’t go on your balance sheet, you don’t show it to your banker when you are getting a loan, but that liability is out there for either A, if you are go to sell your business you shouldn’t close it, or B, if you for somehow get audited by that state, you are going to owe all of that, and what’s the risk?
You’re gonna go owe that out sending sales tax, plus interest, plus penalties. That if you sell for the whole year, currently with the current 20 states, you will generate $50,000 in sales tax liability for every million dollars that you are selling, okay, per year if you are not registered. But keep in mind that if you register and start sending the state money, it might reduce your chance of being audited. But if you are audited and you are registered and collected going forward, if you knew that you had nexus for the last month, six months, three years, there can be some additional penalties in there, but it doesn’t happen very often.
Andrew: What would be your favorite tool for dealing with sales tax? You mentioned a few, from TaxJar, some other ones. Do you have a one that is your favorite if somebody is gonna try to handle this with one of those SaaS solutions?
Scott: If you are small seller and you are under a million dollars and you are just getting started, TaxJar is the easiest to work with. We use Taxify. Taxify has more in-depth, they can file in all the local filings like here in Colorado and Arizona and some of the other craziness. They can do a better job of auto filing everywhere. TrustFile from Avalara has really come a long way and is a solid tool as well, but it would be any of those three. My favorite is Taxify, but they also provide some additional support for us to file hundreds and hundreds of returns, but I consulted them and they are always improving their product.
Andrew: I wanna do a few lightning rounds. The first one we’ll do is kind of a traditional one we do with our guests, but before that maybe a quick lightning round for some of your favorite apps and software. I know there is probably a lot of new ones we can get into for all of these, but let’s say for sake of argument just to make sure we get through and that’s it’s… When I ask you, you are kind of thinking about your favorite choice for, let’s say, a business doing $1 million in sales, e-commerce with say selling on their own store in the Amazon primarily for channels. So what would be your favorite app for bookkeeping? I think I know, but I am just gonna throw it up anyway.
Scott: It’s Xero plus A2X accounting, okay? It has to be that combination of those two applications. A2X will take their settlement statement and post it as a single invoice with all the 80 different Amazon fees. It’s the combination of those two, and it will very soon do all the cost of goods sold in inventory as well. If you are on Amazon-only business, that will cover between the automation in Xero and A2X, that will cover the bulk of the accounting for you.
Andrew: What about inventory management? And let’s say a $1 million retailer with, let’s say, 100 in-house skews in their inventory.
Scott: I can’t give you one app. I can give you my top three or four apps, because it depends on your business and everybody should look at them. So there isn’t one, but it’s…I would say, it’s Veeqo, which is V-E-E-Q-O. Skubana, we have most of our clients who are on Skubana. And then, even ShipHero, if you are really looking at warehouse management, and then DEAR if you have any light manufacturing. It’s really those four, and there are bazillion others. We have clients on other five different platforms, but those seem to be the most common ones that I like from user interface, ease of use, and everything else.
Andrew: What about a centralized ERP for, let’s say, $1 million business with just a little bit of light manufacturing and bundling for their in-house inventory?
Scott: So I consider cloud inventory in the ERP, because most of them are enterprise resourced planning. If you are doing any light manufacturing then, it’s DEAR Inventory and it’s out there. If you want more functionality, like listing or repricing, which a lot of these cloud inventory platforms are adding, there are certainly ones like Zentail. There is definitely a whole list of Zentail and SellerActive, which will give you alternatives to ChannelAdvisor, but you don’t need a separate solution.
You can do some bestir breed and some add-ons to integrate in things like package B to get to 3PL sites. And it’s just you want a core tool and then you wanna optimize wherever you run into challenges. They are always evolving, and one of the things I like about this industry is there isn’t necessarily one way to do e-commerce and there isn’t just one tool.
Andrew: What about…? Obviously here is a ton of different apps for Amazon from metrics to accounting, all sorts of things, but if you have one that you are just in love with for Amazon across any need base, what would it be?
Scott: I have to say it’s A2X accounting because you just can’t know it… It only works with Xero. That would be the one.
Andrew: Okay, great. And tell us a little bit about Catching Clouds. Of course, that’s the accounting and bookkeeping company that you run. What do you guys do specifically and who you are an ideal fit for?
Scott: So at Catching Clouds, we provide outsourced cloud accounting services for e-commerce businesses. So we are really experts in both e-commerce businesses. You are inventory business, how you should be structured, and all the fundamentals about being a really solid business. We are experts in cloud technology as well as e-commerce technology, cloud inventory, and sales tax management. Then, of course, we do the accounting. So we’re doing the daily bookkeeping, the weekly accounting, and the month-end controller services to make sure that the books are completely accurate.
We are the accounting department, we take over all of the accounting, and we do everything but federal and state income taxes, so we’re not a CPA service. So we provide the automation to set up these tools, to clean up all the accounting back in time, so you actually have accurate financials back to the beginning of this year, the previous year if you need them, and then you have a dedicated e-commerce accountant that you know by name, somebody here who lives in Colorado. We are all in Colorado.
And then we really take everything over, and then a controller who will answer, analyze your profit-loss statement, your balance sheet, and really provide guidance and answer all questions of what’s going on. Not only do we do the work to keep everything up-to-date on a daily, weekly basis but we also provide the guidance and insights, and somebody you can talk to about your business that cares about your business that’s gonna say, “Hey, you are spending too much on marketing,” or, “Hey, you have X amount of cash available.”
We are perfect for those businesses that are between 1 and 20 million, typically the more complex businesses and people who are ready to actually know what’s going on in their businesses financially.
Andrew: You can learn more about Scott and what they can do for your businesses at catchingclouds.net. And, Scott, before I let you go, I wanna do a kind of fun that cheeky lighting round here that we do with all our guests.
Andrew: Super fast, it’s quick questions, quick answers. How much money is enough? What would be your number?
Scott: I could probably sleep well and do most things that I want for 10 million, but I need another 100 million or a couple of billion to be Elon Musk, who is just who I wanna be.
Andrew: How many hours a week do you work?
Scott: Ooh, between 60 and 80 most of the time.
Andrew: If there is one thing that’s gonna bring down the fall of civilization in the next 25 years, what would it be?
Scott: Ah, it’s us, it’s humans, especially politicians.
Andrew: Are they the politicians that are ruining with policy or coming at us with shot guns or…?
Scott: Oh, no. Policy.
Andrew: Policy. Let’s say obviously you love running your business. I imagine it’ll be pretty difficult to pry you away from it, to go work for someone else. But say you had to, as part of that bureaucracy demanded entrepreneurship is illegal and you have to go work for another business or another company but you could work for anyone in the world, which business would you wanna work for?
Andrew: Elon, if you are listening and you are interested, get in touch with us. We’ll put you in touch with Scott. All right, last question, where would you live if you could live anywhere in the world and cost practicality in your current community wasn’t an issue? So assume someone would pay for all of your expenses and all of your family and friends would be transplanted there magically. So purely based on just location.
Scott: New Zealand.
Andrew: New Zealand?
Scott: Yeah, yeah, that one is easy.
Andrew: Scott, I really appreciate you coming and talking accounting with us. Again, if you are interested in having Scott help you out with your business, catchingclouds.net. He’s also our accounting expert in the eCommerceFuel forum, and is a fantastic resource. He’s always trying and helping out with tough financial accounting questions. So, Scott, thanks so much for making time to come on.
Scott: Yeah, thank you very much, it’s fun. I appreciate being able to support this community.
Andrew: Want to communicate with and learn from other proven eCommerce entrepreneurs? Join us in the eCommerceFuel private community. It’s our tight-knit, vetted group, for store owners with at least a quarter million dollars in annual sales. You can learn more and apply for membership at ecommercefuel.com.
Thanks so much to our podcast producer, Laura Serino, for all of her hard work in making this show possible, and to you for tuning in, thank you for listening. That’ll do it for this week, but looking forward to seeing you again next Friday.