Knowing the quantity of physical inventory on your shelves is one thing. Knowing its dollar value is another. Fortunately, this is where retail accounting comes in.

All ecommerce store owners need to understand how to value their month end or year end inventory. This valuation helps you know whether your business is profitable, the amount of tax you will pay to the IRS, and impacts your chances of securing a loan.

Retail accounting is a method accountants use to assign a dollar amount to closing inventory. This inventory valuation method uses what is called a cost-to-retail ratio, which you’ll learn to calculate in this guide.

Table of contents

What retail accounting really is

Retail accounting is an inventory valuation method that allows retailers to easily calculate the value of their inventory at the end of a financial period. It differs from other inventory valuation methods because it uses estimates. With retail accounting, you don’t need to count inventory or identify exact costs—it uses average sales margins to value inventory and make financial reporting easier.

The advantages of retail accounting

Unlike otherinventory valuation methods where you have to physically count inventory, retail accounting requires you to know total dollar amounts of sales and inventory purchases. It also handles large volumes of inventory, making it easier for retailers to manage it without tracking each item's specific cost.

Plus, retail accounting is cheap. It minimizes the need for detailed record keeping andtracking each inventory item, which reduces labor costs—staff don’t have to count inventory manually. All you have to do is assume consistent sales margins and know your total sales figures. This allows for faster financial reporting and better decision-making.

When to use retail accounting

Although the retail accounting method is temptingly simple and cost-effective, it may not be suitable for all business types or settings.

The following are situations when using the retail method makes sense:

\nRetailers with stable pricing. This valuation method assumes a consistent sales margin. It won’t suit businesses that experience significant price fluctuations. You can still use it, but the estimates may be far from accurate, leading to a financial outlook that is markedly different from reality.
\nBusinesses with multiple locations. Think about the logistics of a physical inventory count, especially for a business with many locations. Withouta versatile inventory tracking software, especially one that scans items in and out and updates counts in real-time, counting inventory in multiple places can be a logistical nightmare.
\nBusiness owners who prioritize convenience over detail. Retail accounting is simple and convenient. Using estimates to value your closing inventory means you don’t have to count inventory and you can produce your financial statements faster. With accurate and real-time financial data, you can make purchasing decisions faster.
\nRetailers with large volumes of similar products. If most of the products you sell are similar, their sales margins are likely consistent. For these types of products, the retail method will more accurately reflect your actual financial situation.

Limitations and drawbacks of retail accounting

Despite its advantages, retail accounting comes with some limitations every business owner should know:

\nRetail accounting is not precise. If you need more detailed and highly accurate financial reports around inventory cost, retail accounting might not be suitable. It’s based on the assumption of consistent sales margins, which rarely holds true in the real business world. Even gold, often considered stable, experiences considerable retail price volatility. And distortions can arise from fluctuations in both costs and prices.
\nTemporary business activities. Besides price fluctuations, temporary internal business practices also influence retail accounting. For example, during a two-week promotion that includes price discounts, buy-one-get-one deals, and free giveaways, the retail method struggles to accurately incorporate these temporary initiatives. As a result, inventory valuations may become distorted.

Retail vs. cost accounting for inventory

Unlike retail accounting, which estimates the value of closing inventory based on consistent sales margins, cost accounting values inventory using the historical cost of each item. Historical cost refers to the original purchase price of a specific item.

The following are some common methods of cost accounting for inventory:

\nFirst in, first out (FIFO): This method works on the assumption that the oldest inventory items (first in) are the first ones sold (first out). The value of closing inventory under FIFO is based on the most recent historical cost.
\nLast in, first out (LIFO): This method is based on the assumption that the newest inventory items (last in) are the first ones sold (first out). The value of closing inventory under LIFO is based on the oldest historic costs.
\nWeighted average cost (WAC): This accounting method determines the cost of ending inventory using a weighted average of all historical costs, instead of relying on the oldest or most recent prices.

While methods of cost accounting for inventory will still include some estimates, the outcomes of the cost accounting methods are more accurate.

Here’s how to look at these two broad inventory valuation approaches:

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	Retail Accounting	Cost Accounting
Accuracy	Not very accurate because it is based on the assumption of a constant sales margin.	Highly accurate because it's based on the actual historical cost of the inventory items.
Usage	Used by businesses in the retail industry.	Used widely. It’s the default method of valuing closing inventory.
Ease of Calculations	Easy to calculate.	Can be a bit more complex to calculate.
IRS Acceptance	Acceptable	Acceptable
Generally Accepted Accounting Principle (GAAP)	✅	✅

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How to implement retail accounting into your store

The first step in using the retail accounting method is to determine the cost-to-retail ratio you will use. This is straightforward when managing a few products, but it becomes more complex with hundreds of items.

When dealing with many products, it’s best to focus on those that make up most of your sales volume. For example, if you’re selling iPads and the Apple iPad (2022, 10th Gen) makes up 83% of your sales, applying its cost-to-retail ratio to your closing inventory valuation is reasonable.

The problem comes when you’re dealing with several products with widely differing sales margins. In that case, you may need to calculate the weighted average of your cost-to-sales ratio.

For example, if:

Basic tees have a 20% margin and are 70% of your sales
Premium hoodies have a 40% margin and are 20% of your sales
Custom jackets have a 60% margin and are 10% of your sales

You may work out your cost-to-retail ratio as (0.2 × 0.7) + (0.4 × 0.2) + (0.6 × 0.1), which is 28%.

Next, value your closing inventory by subtractingthe cost of goods sold from the cost of goods available for sale. This is the standard procedure with every inventory valuation method. You use a predetermined cost-to-sales percentage because with the retail accounting method, you assume that all your inventory items have the same profit margin.

For example, assume you have a consistent cost-to-sales percentage of 25% on your inventory. That means you buy inventory for $10 and sell it for $12.50. Your sales for the month are $4,000. Yourbeginning inventory value is $1,500, and you purchased inventory worth $2,200.

In this case, your ending inventory value using the retail accounting method would be ($1,500 beginning inventory + $2,200 purchases - $3,000 cost of goods sold) = $700.

As you see, this is only an estimate. You don’t count inventory or verify its costs.

Tools for retail accounting

Shopify POS

One of the most valuable tools for retail accounting is Shopify POS. It offers unified solutions for both small businesses and enterprise retailers managing up to 1,000 stores. With Shopify's unified commerce architecture, all retail operations run on a single platform, eliminating the complexity of maintaining multiple systems.

For small businesses, Shopify POS provides streamlined inventory management, including features that create purchase orders, send low stock alerts, and conduct inventory counts—all operating from the same source of truth.

Unlike traditional retail systems that require complex integrations, Shopify unifies all your data in one platform. Whether a sale happens online, in-store, or through social media, all order, customer, and inventory data flows through a single system. According to research from a leading independent consulting firm, Shopify POS reduces total ownership costs on average by 22% compared to competitors.

\"Chart — The benefits of Shopify’s unified commerce platform are endless.

Shopify POS offers 22% lower TCO

See how Shopify POS reduces retail operating costs and increases revenue better than the competition, based on real data and research conducted by an independent consulting firm.

\nGet the report\n

QuickBooks Online

Recording sales and inventory changes in your accounting records is easy when you connect your Shopify store with QuickBooks Online. You can connect all your Shopify stores to track income and expenses. And your inventory counts sync between QuickBooks Online and Shopify for easy retail accounting.

Children’s boutique Twinkle Twinkle Little One already uses the Shopify and QuickBooks Online integration for easier retail accounting. “The time we’ve saved that would have otherwise been spent managing operational overhead is huge,” says owner Corey Glasson. “That’s time we can invest into actually growing the business. With Shopify, we’re able to be proactive and build for the future.”

Stocky

Stocky is an inventory management app built for Shopify POS. You can use it to automate tedious inventory processes such as creating reports, creating purchase orders for vendors when quantities dip below your predetermined threshold, and receiving new stock.

Take control of your finances with Shopify

Retail accounting can feel like a daunting task, particularly if financial reporting isn’t your forte. Luckily, Shopify has the tools you need to master accounting—which is made possible by unifying your most important data into a central business brain.

Retail accounting FAQ

What is a retail accountant?

A retail accountant is a professional accountant who works in a retail company. Their responsibilities include calculating tax liabilities, filing certain tax returns, reconciling bank statements, creating invoices, and tracking expenses.

What is the difference between retail accounting and cost accounting?

Both retail accounting and cost accounting are closing inventory valuation methods. However, retail accounting estimates the value of closing inventory based on the assumption that the business has a consistent sales margin. Cost accounting relies on the actual historical costs of the closing inventory items.

What is the retail method of accounting?

The retail method of accounting is a method accountants use to value closing inventory by estimating its value.

What is the meaning of retail accounting?

Also known as the retail inventory method, retail accounting is a process used to estimate the value of a store’s ending inventory for a specific period.

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Cash is king and a bank account full of cash feels good. But what happens when your cash dries up? Do you reach for the company credit card to cover everyday business expenses?

Although a credit card is the convenient solution for a cash shortfall, it also has downsides to watch out for, including getting locked into a frustrating debt trap.

One way you can find yourself neck-deep in credit card debt is via credit card floats. Here’s everything you need to know about credit card floats, plus how to avoid them.

Table of contents:

What is a credit card float in finance?

Credit card float has two meanings.

\nLiving on credit card debt: When you’re charging everyday expenses on your credit card and hoping for future income to pay off the previous purchases. This is usually done out of necessity when cash flow is slow.
\nCapitalizing on interest-free lag time: Similar to the OPM (Other People’s Money) idea in finance. Instead of paying for purchases with cash, you pay with a credit card and invest your money during the interest-free period before the credit card payment is due. It’s like taking advantage of a short and convenient interest-free line of credit. This is more of a strategic financial decision because you have the cash to pay for the purchases but choose to invest it during the interest-free period to earn a return.

Too much reliance on a credit card float can be risky. You’ll owe interest to the credit card company if you don’t pay your balance in full on the due date.

Example of a credit card float as debt

Let’s say you have a supplier’s invoice of $40,000, which you need to pay by June 25. The problem is that you only have $30,000 in your bank account and expect to have less than $40,000 by June 25.

You have a corporate credit card with a $50,000 credit limit, and your credit card payment is due on July 10. And you expect to collect $75,000 in cash from monthly customers’ subscription fees on July 1.

So this is what you can do.

You’ll use your credit card to pay the supplier’s bill of $40,000 on June 25, even though you only have $30,000 in the bank. Using a credit card may make sense because the bill on your credit card will be due later on July 10.

By then, you’ll receive the $75,000 monthly subscriptions and have enough money in your bank account to pay the $40,000 credit card bill in full.

Example of a credit card float as an interest-free line of credit

A profitable handbag business purchases $100,000 in leather on September 1 to create its handbags. Although the company has $100,000 in cash in the bank, it charges this amount on a company credit card, which is due on October 2.

The company keeps its $100,000 cash in a high-yield savings account, which earns $300 in interest from September 1 to October 2.

And on October 2, the company pays the credit card account in full with the cash in the savings account and doesn’t pay interest to the credit card company.

In the meantime, the company earned $300 in interest by successfully using a strategic credit card float. It may have come out even further ahead if the credit card offered a cashback or rewards program.

How does a credit card float happen?

Generally, a credit card float happens when you don't have enough cash to pay for expenses and wind up making purchases on your credit card instead. You end up \"floating\" your expenses on the credit card until payment is due.

But a credit card float can also be a strategic decision not born out of necessity. In these situations, you have cash to pay for expenses but elect to invest it instead of using it right away to pay for your expenses.

Cons of allowing a credit card float

Although a credit card float can come in handy in an emergency or earn you some extra cash, it comes with risks you should know.

Risks financial instability

A credit card float can destabilize finances. Let’s say you use a float, which comes to a substantial sum, hoping you’ll get cash before the credit card due date. Unfortunately, the expected cash doesn’t materialize.

When this happens to a business, it can cause considerable immediate and long-term financial instability. The company might be tempted to divert cash earmarked for operations to pay off the credit card float.

But the consequence of diverting cash meant for operations can be crippling. Remember, you’ll still need to pay salaries and utilities, and buy inventory. And you may end up in a cycle of debt, which we discuss next.

Anything that can destabilize your cash flow, including a credit card float, should be handled with extreme care and caution.

Creates a cycle of debt

Another downside of a credit card float is its potential to trap you in debt. You may find yourself using all business income to pay off or reduce outstanding debt, leaving nothing for business growth and development.

Plus, credit card debt can have interest rates that are higher than those of other loan types. This erodes profits, further limiting one's ability to expand and improve.

Potential for increased spending

Even with a budget, credit card float can cause increased spending. Knowing you can spend more than you have in the bank can tempt you to spend more than you need to.

And it is not just buying more things.

Credit card users are likely to buy stuff at a higher price. Behavioral psychologists have long studied the behavior that leads to people’s willingness to pay higher prices when charging a purchase instead of paying cash.

If you have cash in your wallet, it’s something you can see and touch. When you buy something with cash, you give the cash away. But with credit cards, purchases are merely numbers on a screen or piece of paper. The actual cost from your viewpoint is only realized when the credit card bill is received much later.

Impacts credit utilization

Credit utilization refers to the proportion of a cardholder’s available credit currently used.

If you have a credit card with a $50,000 limit and a $25,000 balance, your credit utilization is 50% ($25,000 ÷ $50,000).

Although there should be nothing wrong with maxing out your credit limit if you can pay it without incurring interest, this is often not the case. A high credit utilization can lower your credit score.

Securing future financing becomes difficult with a high credit utilization rate. Lenders see this as a sign of financial stress and may be reluctant to offer favorable terms. Which means you’ll pay higher interest rates.

Interest and fees risk

Managing unsustainable debt levels isn’t the only downside of a credit card float.

Credit cards aren’t interest-free. Failing to pay your balance in full means you’re stuck paying interest on the current unpaid portion and on the next month’s purchases. With credit card interest rates nearing 25%, interest expenses can quickly pile up, leaving you with less cash for growth or investments.

Should you “Ride the Float”?

To ride the credit float — to use credit to cover the cash you don’t have at the moment — should come with well-thought-out considerations.

On one side, holding onto cash until the end of a credit card’s float period technically means you have some cash reserves you can fall back on in an emergency.

But riding a credit card float can be risky. For example, what if you don’t have the cash to pay the credit card charges when your bill becomes due?

Or, you can find yourself in a position with enough cash to pay the credit card bill but not enough to cover your current month's operational expenses, leading to a frustrating cycle of debt.

To know if you should ride your credit card float, draw up conservative budget projections to make sure you have enough money to cover your bills and track your spending. If you're consistently spending more than you budgeted, there may be better choices than a credit card float.

Riding the float requires discipline and careful planning. Without those two, it’s best to avoid the risks of potential interest charges and debt accumulation.

Options to cover expenses without doing a credit card float

Fortunately, a credit card float is one of many ways to cover your business expenses. The following are other creative options you can explore without the back-and-forth hassles common with traditional bank lending.

Cash advance

One of the most common types of cash advance for ecommerce businesses is the merchant cash advance. In this type of loan, a lender gives a borrower a lump sum based on the borrower's historical sales. To hedge their bets, lenders typically receive repayment via a percentage of future credit card-based sales.

Invoice factoring

Invoice factoring involves selling unpaid customer invoices to a third party for immediate cash. These lenders typically give the borrower a percentage of the unpaid invoice value. The lender then collects the amounts on unpaid invoices directly from your customers.

Business loan

The standard type of business loan is a term loan, or a one-time lump sum advanced by a lender to a borrower that the borrower will repay with interest over a set period. The primary advantage of term loans is that they have lower interest rates compared to other forms of business financing.

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Working capital

One of the major challenges entrepreneurs face is how to finance a business, especially the day-to-day operational needs. This is where working capital comes in.

Using working capital means using your current operations to fund your current operations. In other words, using your cash, inventory (by selling it), and accounts receivable (by collecting it) to pay your current expenses (like salaries, rent, utilities, and insurance). This requires careful budgeting and keeping a close watch over cash flow.

Business line of credit

A business line of credit works almost like a business credit card. Lenders give borrowers a credit limit, which they can draw on as needed. The amounts borrowed are often paid back with interest when due. Funds related to lines of credit are typically accessible through a mobile app or a business checking account.

Other types of floats in finance

In finance, floats come in various forms. The following are some common types of floats in finance.

Cash float

A cash float is when there’s a brief delay between the movement of funds from one bank account to another.

Examples of cash floats include receiving a customer’s check but not immediately cashing it, or paying a vendor’s invoice, but the payment hasn’t been processed through the banking system and subtracted from your bank account.

Disbursement float

Disbursement float is a type of cash float when the cash in your bank account is higher than the equivalent amount in your company’s accounting system. A disbursement float can happen for several reasons, including when you pay suppliers via check and the supplier doesn’t immediately process the check.

Disbursement float can also occur with electronic payments because of bank processing times and weekend or holiday transactions.

Collection float

Collection float is another type of cash float when the actual cash in your bank account is lower than the equivalent amount in your company’s accounting system. Collection floats occur when you receive check payments from customers but don’t immediately cash them at the bank.

Net float

The net float is the total of all cash floats, including the collection and disbursement floats. ‍Big companies that handle many check-based transactions often have bigger net floats.

Stay free of credit card floating

Ditch the credit card float by paying balances in full and tracking spending against your budget. Because of their high interest rates, credit cards should be the last resort for paying expenses or accessing cash. Instead, explore other lending optionsto avoid finding your business in the frustrating debt trap.

Get funding to run and grow your business through Shopify Capital

Shopify Capital makes it possible to receive funding in as fast as two business days, if approved, and use it for inventory, marketing, and more. Automatically make payments as a percentage of your daily sales.* No compounding interest. No schedules. No surprises.

\nExplore Shopify Capital\n

Credit card float FAQ

How does using a credit card float affect my financial health?

A credit card float has the potential to seriously destabilize your finances, plunge you into a frustrating cycle of debt, and lower your credit score, especially if your utilization rate is high.

Can credit card float lead to debt accumulation?

Because it’s often easy to spend money you don’t have, credit card floats can easily lead to debt accumulation.

How can I recognize if I’m relying on a credit card float?

Signs that you’re in a credit card float include:

Not paying your balance in full.
Using multiple credit cards regularly to cover expenses.
Having a bank balance consistently lower than your credit card balance.

*Shopify Capital loans must be paid in full within 18 months, and two minimum payments apply within the first two 6 month periods.

","Stuck in credit card debt for your business? Learn what the credit card float is & how to break free. Grow your business, not your debt."," $\"a$ \n

Stuck in credit card debt for your business? Learn what the credit card float is & how to break free. Grow your business, not your debt.

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As a business owner, you’re intimately familiar with sales. But when, specifically, does a sale occur? Is it when you receive cash or when a customer payment hits your bank account?

Or, is it when you deliver an item, perform a service, or when the customer receives your invoice?

Recognizing revenue is not just posting the money that flows in. Various factors must be considered, and specific events must occur.

Fortunately, accounting rules spell out when to record revenue, and this article covers the details.

Table of contents:

What is revenue recognition?

Revenue recognition is a set of accrual accounting rules (we’ll discuss what accrual accounting is later) that define when a company can record a sale as revenue. These rules ensure companies report their earnings accurately and consistently.

The key considerations to recognize revenue are:

Timing
Performance obligations
Transfer of control
Measurement

How revenue recognition works

Revenue recognition depends on how a business maintains its accounting records

Businesses manage their finances using two methods: cash and accrual. What qualifies as revenue using one method may not qualify using the other.

Depending on the size of your ecommerce business, one method may work better than the other.

Smaller companies without inventory tend to use cash accounting because it’s intuitive and uncomplicated. But accrual accounting is the standard for most businesses, particularly those with large inventories, recurring revenue, and more than $500,000 in annual revenue.

Cash accounting

Cash accounting is when businesses record financial transactions only when cash exchanges hands. It’s like managing personal finances: tracking money in and money out.

For revenue recognition, cash accounting requires businesses to record sales when cash is received from their customer.

Assume you operate an ecommerce store selling footwear and you sell (and deliver) shoes worth $5,000 on December 31. But your customer pays you on January 3. Using cash accounting, you’ll record the $5,000 of revenue on January 3, not December 31.

Although cash accounting is fairly straightforward, it has limitations. For instance, cash accounting doesn't capture a company’s liabilities (what it owes to others) and receivables (what others owe it), making it difficult to get a complete and accurate picture of a business’s financial health.

This is where accrual accounting is useful.

Accrual accounting

If you’re not using the cash method of accounting, you’re using the accrual method.

Accrual accounting is when a business records revenue when it earns it, which might not be the same time it receives payment. Expenses are recorded when incurred, not necessarily when payment is made.

With accrual accounting, your attention shifts from the movement of cash to identifying the point at which income is earned and costs are incurred. For example, is income earned when you receive cash, deliver a good, receive an order for an item, or issue an invoice?

According to best practices, under the accrual method, revenue is earned at the point a customer is contractually obligated to pay for a product or service.

In a sales transaction, the point a customer must pay for a product or service is when the item ships or when the service is provided.

Assume a footwear ecommerce store receives an order from a customer named Olivia for a pair of shoes worth $500. Olivia is obligated to pay for the shoes when they ship, not when she submits the order. The moment the shoes leave the store's warehouse, the footwear company should record the $500 as sales in its books, even if Olivia doesn’t immediately pay for the shoes.

The other key thing with the accrual method is that revenues should be recognized in the same period a business incurs the related costs.

Consider how a subscription-based cosmetics company would record revenue. Assume a customer pays upfront for a one year subscription, with subscription boxes received each month. The business can’t recognize the entire payment when it’s received. Instead, it should match the revenue as it incurs the costs of providing the subscription boxes.

So if the business charges $100 per month for its cosmetics boxes, and a customer pays $1,200 for one year on October 1, the business records only $100 as revenue for October to match the costs of the cosmetic box sent to the customer. It continues to record $100 each month as revenue for the next 11 months.

It’s important to note that the IRS requires companies to earn more than $25 million in average annual revenue and publicly traded companies use the accrual method of accounting.

International standards

Imagine an ecommerce store in Memphis using a mashup of cash and accrual methods to record revenue and keep its books. Meanwhile, another ecommerce store in Seattle records its revenues the way it sees fit. This can cause a lot of confusion if you compare the two companies’ financial results.

To avoid this freestyle approach, the accounting profession has professional boards that set rules on how financial transactions are recorded and financial statements are prepared. These rules address the revenue recognition principle.

There are two main sets of accounting rules.

\nU.S. GAAP, which stands for Generally Accepted Accounting Principles
IFRS, which stands for International Financial Reporting Standards

U.S. GAAP was created by the Financial Accounting Standards Board (FASB) and is used in the U.S.

IFRS, created by the International Accounting Standards Board (IASB), is used worldwide.

Although there are subtle differences in revenue recognition between U.S. GAAP and IFRS, they don’t substantially differ from each other. In this article, however, we’ll focus on U.S. GAAP.

The 5-step revenue recognition model

The section of U.S. GAAP that discusses revenue recognition is ASC 606. ASC stands for Accounting Standards Codification and is a shorthand way to refer to specific parts of U.S. GAAP.

ASC 606 sets out a 5-step process businesses should use for revenue recognition.

Step 1: Identify the contract with the customer

Recognizing revenue starts with a contract between the customer and the company. The contract can be written, verbal, or implied through customary business practices.

Regardless of form, a valid contract needs:

Identifiable parties (e.g., customer and company)
Enforceable rights and obligations for both parties
Consideration and genuine business purpose
Collectability

Examples of documentation that can create a valid contract include:

Formal written contracts, like purchase orders or sales contracts
Quotes or proposals accepted by the customer
Email communications confirming the agreement
Standard terms and conditions

Step 2: Identify the contract’s specific performance obligations

A contract must show what the company must do to get paid by the customer. This is known as the performance obligation.

Keep in mind that performance obligations must:

Give customers control of the good or service
Have distinct value to the customer; meaning it could be sold separately
Have contractual wording of what’s included in each obligation

For a single good or service, like selling a pair of shoes for $100, the obligation is typically to deliver them to the customer.

What happens when you sell a bundled service or a series of distinct goods or services?

A bundled service, like software installation and training, can be a single obligation because the customer wouldn’t value the training without the software. Or vice versa.

If you’re selling a series of distinct goods, like a monthly cosmetics subscription box, each monthly delivery is a separate performance obligation.

Step 3: Determine the transaction price

The transaction price, the amount a business expects to be paid for performing an obligation, should be specified in the contract.

Aside from the money a business expects to be paid, the transaction price should include non-cash items like discounts, credits, and barter arrangements to reflect the total the company expects to collect.

Although determining the transaction can be straightforward, many times that is not always the case.

What happens if the contract allows the customer to ask for a refund?

When the transaction price can be variable, like with refund clauses or performance goals, the company needs to determine the likelihood of the variable happening and the magnitude, in dollar amount, if the variable occurs.

\n\n

Step 4: Allocate the transaction price to distinct performance obligations

ASC 606 requires businesses to allocate the total transaction price to each performance obligation “based on the relative standalone selling price of the goods or services underlying each performance obligation.” This allocation is important because it determines how much revenue to recognize with each obligation.

Allocating the transaction price is straightforward when there is only one good or service sold.

But what happens when a bundle of items are sold for a set price?

When more than one item is sold in a bundle, a company can allocate the transaction price using:

\nStand-alone selling price: Assumes that each obligation can be sold separately to the customer at fair market value.
\nProportional method: Used when defining a fair market value for an obligation is impractical. Instead, the transaction price is divided proportionately based on the relative size of the obligation compared to others.

Let’s review an example to see how this works in practice.

Assume a software developer designs and implements a custom CRM for a customer. The developer designs, implements, and trains the customer’s employees on the new software.

The contract is for $70,000 and is broken down into:

$40,000 for design and coding
$20,000 for implementation
$10,000 for training

If we assume the fair market value of each obligation is the same as the contract breakdown shown above, the developer would record revenue:

$40,000 upon completion of the design and coding
$20,000 upon successful implementation
$10,000 upon completion of employee training

But if the fair market value for each obligation is difficult to calculate (which is likely the case in this example), the developer would use the proportional method.

Phase 1: Design and coding - most complex, resource intensive, and highest value for the customer
Phase 2: Implementation - less complex but necessary for using the software
Phase 3: Training - least complex but adds value for the customer

Using the developer’s calculated complexity-to-value ratio, it decides on a proportional allocation:

Phase 1: 70%
Phase 2: 20%
Phase 3: 10%

Revenue recognition under the proportion method would be:

Completion of phase 1: 70% x $70,000 = $49,000
Completion of phase 2: 20% x $70,000 = $14,000
Completion of phase 3: 10% x $70,000 = $7,000

Step 5: Recognize revenue when you fulfill each performance obligation

The last step in the revenue recognition process requires companies to record revenue in their financial records when each performance obligation is completed.

Types of revenue recognition

The following are some common types of revenue recognition.

Digital subscriptions (SaaS)

Businesses like Netflix or software providers, where customers sign up for a service for a specified period, should recognize revenue on a straight-line basis where an equal portion of revenue is recognized for each period the customer has access to the service.

Physical subscriptions

If you offer a subscription for a physical item like a magazine or gift box, revenue is recognized when the item is delivered to the customer.

Ecommerce

Ecommerce stores should recognize revenue when they ship products.

Installments

Businesses offering installment payment options should recognize revenue when they deliver the product or provide the service.

Digital goods and products

Companies selling digital goods and services that are downloadable, including e-books and movies, should recognize revenue when clients download the digital products.

How Shopify helps with revenue recognition

Shopify helps businesses with revenue recognition in three ways.

\nTaxes: Businesses collecting sales tax can set Shopify to automatically handle the most common sales tax calculations.
\nDetailed sales analytics: Businesses can use Shopify's analytics to glean deeper insights into their sales and customers to design relevant marketing strategies for future sales goals.
\nFacilitating returns and exchanges: Thanks to Shopify Admin, businesses can easily refund orders, create returns, and add exchange items for customers.

Take the stress out of sales tax with Shopify Tax

With Shopify Tax, you can oversee your current sales tax obligations from Shopify admin, collect the right amount at checkout with product and location-specific accuracy, and let Shopify automatically apply rate and regulatory changes whenever they happen.

\nExplore Shopify Tax\n

Revenue recognition FAQ

What are the 5 criteria for revenue recognition?

The five criteria of revenue recognition is a ladder-like procedure and include:

Identifying the contract with the customer
Identifying separate performance obligations
Determining the transaction price
Allocating the transaction price to the various performance obligations
Recognizing revenue in the books of accounts.

What is the GAAP rule for revenue recognition?

According to U.S. GAAP, revenue is recognized when a good or service is transferred to a customer, and the amount recognized reflects the expected payment from the customer.

Can you recognize revenue before invoicing?

Yes, you can recognize revenue before you invoice a customer. Revenue is recognized when you satisfy your performance duties under a contract and that may happen before you get around to invoicing your customer.

","Master revenue recognition in your business. Learn when and how to record sales for trustworthy financial reports."," $\"a$ \n

Master revenue recognition in your business. Learn when and how to record sales for trustworthy financial reports.

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A common mistake business owners make is confusing cash flow with profits.

Although cash flow and profit are related, they are not the same. Knowing what each means can give you a clearer insight into your company’s financial health.

Table of contents

\n\n

Cash flow vs. profit: What’s the difference?

Cash flow refers to the money that flows in and out of a business, while profit is the surplus after deducting expenses from revenue.

You’ve probably noticed that your business financial accountbalance rarely equals your company’s actual profits.

There are main reasons for this:

\nTiming: Profit reflects what your company has earned, not necessarily what it’s collected in cash yet. You may have sales made on credit (increasing your profit but not affecting your cash flow) or expensesyou’ve yet to pay (reducing your profit but not affecting your cash flow).
\nNon-cash items: Profit includes accounting adjustments that don’t affect cash flow. Things like depreciation, amortization, and stock-based compensation all influence profits, but don’t involve cash.

Let’s look at some examples.

Transactions affecting profits, but not cash flow

Assume a jeweler sells a $5,000 engagement ring on June 1 and provides the buyer 12 months interest-free financing with the first payment due July 1.

The jeweler records the $5,000 as revenue on June 1. But records no cash inflow until July 1. The impact of this sale on the jeweler’s financial records for the next year looks like this:

\n\n\n

\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n

Date	Revenue Impact	Cash Flow Impact
June 1	$5,000	N/A
July 1	N/A	+ $416.67 ($5,000 ÷ 12)
August 1	N/A	+ $416.67 ($5,000 ÷ 12)
September 1	N/A	+ $416.67 ($5,000 ÷ 12)
October 1	N/A	+ $416.67 ($5,000 ÷ 12)
November 1	N/A	+ $416.67 ($5,000 ÷ 12)
December 1	N/A	+ $416.67 ($5,000 ÷ 12)
January 1	N/A	+ $416.67 ($5,000 ÷ 12)
February 1	N/A	+ $416.67 ($5,000 ÷ 12)
March 1	N/A	+ $416.67 ($5,000 ÷ 12)
April 1	N/A	+ $416.67 ($5,000 ÷ 12)
May 1	N/A	+ $416.67 ($5,000 ÷ 12)
June 1	N/A	+ $416.67 ($5,000 ÷ 12)

\n\n\n

Now assume the same jeweler needs to pay his salesperson a commission for selling the $5,000 engagement ring. The commission is 10% of the sales price and commission payments are made on the last day of the month.

The jeweler will record the commission expense on June 1 but won’t pay it until June 30. The impact on the financial records looks like this:

\n\n\n

\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n

Date	Expense Impact	Cash Flow Impact
June 1	$500 ($5,000 x 10%)	N/A
June 30	N/A	- $500

\n\n\n

Transactions affecting cash flow, but not profits

Suppose an ecommerce lamp store keeps its inventory in a rented warehouse for $1,000 per month and is required to pay rent six months in advance. Rent payments are due on January 1 and July 1 each year.

The lamp store will pay out $6,000 on January 1, but only $1,000 is recorded as an expense on January 1. Remember expenses are recorded when incurred, not when paid.

The impact on the financial statements of prepaying the rent looks like this:

\n\n\n

\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n

Date	Expense Impact	Cash Flow Impact
January 1	$1,000 ($6,000 ÷ 6)	- $6,000
February 1	$1,000 ($6,000 ÷ 6)	N/A
March 1	$1,000 ($6,000 ÷ 6)	N/A
April 1	$1,000 ($6,000 ÷ 6)	N/A
May 1	$1,000 ($6,000 ÷ 6)	N/A
June 1	$1,000 ($6,000 ÷ 6)	N/A

\n\n\n

What is cash flow?

Cash flow is the movement of cash into and out of a business. It can have positive cash flow (money in exceeds money out). Or it can have negative cash flow (money out exceeds money in).

A cash flow statement summarizes the cash a business generates and spends. The cash flow statement groups similar types of transactions together to provide business owners with meaningful insight into sources and uses of cash.

What are the types of cash flow?

There are three groups of cash flow that a business owner should know about. And these three types appear on a cash flow statement.

Operating cash flow
Investing cash flow
Financing cash flow

Operating cash flow

Operating activities are the regular, day-to-day financial functions of a company’s core business activity. They’re essential to generating revenue and keeping the business running.

Operating cash flow is the cash inflows and outflows related to the core business of a company.

Operating cash flow is an important indicator of a company’s financial health. It reveals the amount of money a business generated (or lost) from its core activity.

Let’s use Amazon’s Consolidated Statement of Cash Flow for December 31, 2023 as an example.

Remember that a company’s income statement will include non-cash expenses. And a cash flow statement reconciles a company’s income statement that includes non-cash expenses to actual cash movement.

Amazon

\n\n

Amazon’s cash flow statement starts with its net income figure (shown in the yellow boxes) from the income statement and makes adjustments for non-cash expenses such as depreciation, amortization, and stock-based compensation (shown in the purple boxes). This calculated adjusted net income is then further adjusted for changes in balance sheet items related to operating activities, including receivables, trade payables, and inventories (shown in the red boxes).

For the year ended December 31, 2023, Amazon’s core business operations generated $84.9 billion in operating cash flow (shown in the green box).

A business needs most of its cash flow to come from its core operating activity to be sustainable. These operating cash flows allow companies to make investments for growth and pay off debt.

Operating cash flow benchmarks vary by industry. Warning signs appear if 10% or less of your company’s cash flow comes from its operating activities consistently. This points to a bigger issue like selling unprofitable goods or services, relying too much on debt for cash inflow, or investing or growing at an unsustainable rate.

Investing cash flow

Investing cash flow, also called cash from investing activities, are cash inflows and outflows for items you hope will make you money in the future. It’s like planting seeds now with the goal of harvesting more cash later.

For example, when an ecommerce store buys new computers, purchases stocks or bonds to hold for investment gains, or works with a chemist to formulate a new vitamin supplement to add to its catalog, it’s making investments in its future cash inflows. This kind of cash outflow is called investing cash flow.

A company can also have cash inflow from investing activities. When it sells the computers or sells its stock or bond investments, it will have an investing cash inflow.

Let’s look again at Amazon’s cash flow statement for December 31, 2023.

Amazon

\n\n

The items in the blue boxes show that in 2023, Amazon’s investing activities included:

Purchased property and equipment for $52.7 billion
Sold property and equipment for $4.6 billion
Purchased other businesses for $5.8 billion
Sold some of its investments in the stock market for $5.6 billion
Purchased investments in the stock market for $1.5 billion

\n
Financing cash flow

Financing cash flows are all about the cash a company raises or uses to fund the growth and operations of a business. Businesses, including ecommerce stores, sometimes require external cash for a specific need.

External cash sources could come from SBA loans, lines of credits, or selling a portion of your company’s equity to an investor.

Businesses also use cash to repay lenders or distribute earnings to investors. These payments take the form of principal repayment, interest expense, or distributions to owners.

Let’s take one more look at Amazon’s December 31, 2023 cash flow statement.

Amazon

\n\n

The items in the orange boxes show that in 2023, Amazon’s financing activities included:

Cash proceeds from issuing short-term debt was $18.1 billion
Repayments of short-term debt totalled $25.7 billion
Repayments on long-term debt were $3.7 billion
Lease payments totalled $4.4 billion
Repayment of other financing obligations was $271 million

What is profit?

Recall from earlier that profit is the surplus of revenue after deducting expenses. But if you have more expenses than revenue, you have a loss—not negative profit.

What are types of profit?

There are three different profits.

Gross profit
Operating profit
Net profit

Gross profit

Gross profit is the amount a business earns exclusively from its primary business activity. It’s calculated as:

Gross profit = Net sales revenue - Cost of goods sold

For resellers, gross profit is the net sales price minus the costs of the items purchased and resold.
For manufacturers, gross profit is the net sales price less the costs of raw materials and manufacturing expenses for the products sold.
For service-oriented businesses, gross profit is the net sales amount after deducting the direct costs related to the service provided.

To illustrate, consider a reseller that buys waffle makers at $10 and sells them at $30 each. Assume the business buys 20 waffle makers and sells all of them. Its revenue will be $600 (20 x $30), its cost of goods sold will be $200 (10 x $20), and its gross profit will be $400 ($600 - $200).

\n\n\n

\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n

Category	Amount
Sales	$600
Cost of Goods Sold	($200)
Gross Profit	$400

\n\n\n

The gross profit amount shown above means the business is making $400 to pay for other expenses like marketing, administrative staff, and rent.

Operating profit

Operating profit is the next step in calculating profits. After gross profit, you want to look at operating profit.

Operating profit is what a business earns from its core activity after deducting all of its operating expenses and before considering taxes or other non-operational financial activities.

Operating expenses include things like:

Salaries and wages
Rent
Utilities
Marketing
Bank fees
Shipping and postage
Software subscriptions

Let’s use Amazon’s December 31, 2023 Income Statement (they call it the Statement of Operations).

Amazon

\n\n

In the pink boxes you see Amazon had operating income (it’s the same thing as operating profit) of $36.9 billion for 2023.

Net profit

Net profit, also called net income, refers to the amount a business earns after deducting all business expenses, including cost of sales, operating expenses, interest expense, and taxes.

Net profit is a holistic view and shows the total profit a business has earned, whether from its core business or non-core business.

One last look at Amazon’s December 31, 2023 financial statements illustrates net profit.

Amazon

\n\n

The bottom of its Statement of Operations outlined in the blue boxes shows Amazon made a net profit (net income) of $30.4 billion in 2023.

Improve your cash flow and profits in 2024

Looking for ways to improve your company’s cash flow and profits? Give these suggestions some thought.

How to improve cash flow

\nLiquidate stale inventory: Sell outdated or stale inventory for a discounted price. Consider wholesalers or resellers who might buy your old inventory in bulk.
\nExpense reduction: Identify areas where you can cut expenses without compromising product quality or customer experience.
\nUse financing wisely: Take advantage of proactive financing to grow and accelerate your business. But review your profits to ensure your company can afford the payments.

How to improve profit

\nReview your pricing strategy: Analyze which products have higher margins and prioritize promoting or upselling those. Or create bundles of products to create higher margins.
\nConsider dynamic pricing: Test dynamic pricing by adjusting prices based on demand, competitor pricing, or customer segments to get the maximum value while remaining competitive.
\nAim for efficiency: Automate repetitive tasks and invest in productivity tools to improve efficiency.

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Cash flow vs profit FAQ

What is better cash flow or profit?

Both are necessary for a successful business. Ideally, you want both—positive cash flow and healthy profits. Start-up businesses should prioritize cash flow to establish themselves and secure investor funding.

Why is cash flow lower than profit?

Cash flow is typically lower than profit for companies that sell high-profit products on credit to customers. The business shows a profit on paper but may struggle to cover current expenses because of a cash shortage.

How can you be cash flow positive but not profitable?

You can be cash flow positive but not profitable from one-off, non-recurring items, like receiving loan proceeds or selling equity in your business for cash while having high expenses that contribute to your lack of profitability.

Is cash flow another term for profit?

No. Cash flow differs from profit. Cash flow is money in and money out of your business. Profit includes both cash and non-cash expenses in its calculation.

","Cash flow vs. profit? They’re not the same. Learn the difference, the formulas, and tips to improve both."," $\"coins$ \n

Cash flow vs. profit? They’re not the same. Learn the difference, the formulas, and tips to improve both.

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As a business owner, you know revenue is the amount you earn when you sell your product or service.

But what happens if a customer pays you in advance? You get the cash but have done nothing to earn it. This is where deferred revenue comes in.

Ahead, you’ll learn the basics of deferred revenue and how it works in accounting for your business.

Table of contents:

What is deferred revenue?

In business, a customer sometimes pays for a service they will receive six or even 24 months later. So, you have the cash, but you haven’t performed the service or delivered any product yet.

Deferred revenue is the money a business receives from a customer for future services or products. Think of purchasing a gift card.

Imagine you purchase a $100 gift card from your favorite bookstore. The store collects your $100, but hasn’t sold you any books. The bookstore will record the $100 as deferred revenue until you redeem the gift card.

Accounting rulesdon’t allow the store to recognize the entire $100 as revenue because it has done nothing to give it a legitimate claim to that money.Even if not explicitly stated, business transactions are contractual with duties and rights for each party.

In the above example, the store has a duty to sell books to you and then has a right to the cash in on your gift card after giving you the books. The cash you receive before providing a service or delivering a product is called deferred revenue. You can also think of it as postponed revenue or unearned revenue.

How deferred revenue works in accounting

A set of accounting principles define how transactions are recorded in a company’s books of accounts. There are ten accounting principles and the revenue recognition principle is the most relevant for deferred revenue.

According to the revenue recognition principle, revenue is recorded when it’s earned, regardless of when the cash payment is received. For example, assume a SaaS company sells a two-year software license and receives $100,000 as full payment. The company can’t immediately recognize $100,000 upfront as revenue because it hasn’t earned it.

Instead, it recognizes revenue bit by bit as it delivers the software service over the two-year period.The company will record $4,166 in revenue ($100,000 ÷ 24 months) each month for the two-year licensing period.

Businesses must record any advance cash payments as deferred revenue until they earn them by providing the service or delivering the product. Take a look at Amazon’s December 31, 2023 Balance Sheet.

Ignore all the words and numbers and only look at the items surrounded by red boxes.

On December 31, 2023, Amazon had $15.2 billion in unearned (deferred) revenue. As you read further through Amazon’s annual financial report, you learn that its unearned revenue is the following:

Deferred revenue vs. accrued revenue

There is a subtle difference between deferred revenue and accrued revenue. Remember that deferred revenue occurs when a business receives cash, but hasn’t provided a service or delivered a product.

Accrued revenue is the opposite of deferred revenue. It’s when a business hasn’t received payment for goods or services already provided. Another one of the 10 fundamental accounting principles is the accrual principle.

According to the accrual principle, transactions are recorded in the books of accounts when expenses are incurred or revenue earned, regardless of when cash exchanges hands. For example, you record salary expenses when you have an obligation to pay, not when you direct deposit paychecks to your employees’ bank accounts.

Similarly, you record revenue when you give a customer a product as agreed, not when you receive the cash. Accrued revenue is the same thing as accounts receivable. It’s when a customer owes you money. You shouldn’t omit these amounts from your financial books.

The same holds for expenses. Don’t leave them out of your financial statements. Assume, for example, that a business hasn’t paid salaries for a month. When the business closes its books at the end of the month, it needs to recognize the unpaid salaries as an expense and a liability.

How deferred revenue affects financial statements

Revenue is an income item and shows on the income statement. How about deferred revenue? In accounting, deferred revenue affects the financial statement differently because it is a liability, not income.

Here’s the reasoning.

The cash you receive for a service you haven’t provided is technically not yours. You’re keeping it in trust. It will pass to you only when you earn it. And circumstances can change, especially before you perform the agreed-upon service.

For example, let’s say a customer paid you$10,000 for a two-year SaaS software license. What happens when the next morning the customer changes their mind or experiences a significant business disruption and requests a refund?

Of course, you can flash a no-refund policy and keep the cash. But you did nothing to deserve the cash and therefore, should be obligated to pay it back.

Somehow, accounting captures this sense of natural justice by stating that deferred revenue should be recognized as a liability, not income. Once you’ve delivered the service or product paid for in advance, the deferred revenue liability disappears. You then record that amount as revenue.

How to manage and track deferred revenue

The best way to manage and track deferred revenue is with a revenue recognition schedule. This schedule captures the total initial advance payment, and then gradually reduces the amount as the business performs the agreed-upon service.

Suppose you have a customer who signs a 12-month contract for $12,000 on January 1. The contract has a recurring quarterly fee of $3,000.

Your revenue recognition schedule will look like this:

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\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n

Period	Revenue Recognized to-date	Deferred Revenue Balance
January 1	$0	$12,000
March 31	$3,000	$9,000
June 30	$6,000	$6,000
September 30	$9,000	$3,000
December 31	$12,000	$0

\n\n

Knowing the deferred revenue portion can help prevent overspending because it represents future service delivery commitments and potential refunds. Plus, tracking deferred revenue can help businesses create more accurate and realistic cash flow predictions to plan for things like staffing needs and marketing initiatives.

Tracking deferred revenue means more accurate financial statements. Imagine in the above example that the company signed the 12-month contract in December, and the company recorded the entire $12,000 as revenue in December.

That means December revenue is inflated, and the company will show no revenue for the following year. Today, technology has made managing and tracking deferred revenue a lot easier.

Most accounting software has revenue recognition features that update deferred revenue in real time. These accounting systems provide charts, graphs, and tables breaking down revenue by month, showing what the company has earned and what’s still deferred.

Risks with deferred revenue

It may look simple, but deferred revenue comes with a set of risks businesses should be prepared to navigate. How you manage some of these risks can improve the financial health of your business or make a customer somewhere happy and satisfied.

The following are some common risks associated with deferred revenue.

Cash flow management challenges

One of the most common risks with deferred revenue is cash flow management. Consider a company that receives a large sum of cash from a customer at the start of the year for a one year software implementation project.

But the company uses all of that cash to finance growth and expansion with new marketing initiatives. And that leaves no cash to pay the consultants’ salaries doing the implementation throughout the year.

Without careful planning, the company might find itself cash-strapped midway through the project, potentially jeopardizing the project's success and the company's financial solvency.

Incorrect financial statements

Recording deferred revenue and keeping track of it can be complex, requiring strong accounting processes. Errors in tracking deferred revenue can lead to financial statement errors.

This, in turn, can mislead investors, creditors, and even regulatory bodies. In some cases, non-compliance with accounting standards and regulations can result in penalties, fines, and legal repercussions.

Customer service risks

Failure to record deferred revenue can easily cause a business to lose track of its commitments. This can lead to delays or failures in fulfilling customer orders, which is frustrating for them.

Customers expect businesses to honor their commitments. When a company fails to deliver on its promises due to poor management of deferred revenue, it erodes customer trust.

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Deferred revenue FAQ

Is deferred revenue a good thing?

Although deferred revenue is a liability, it is not necessarily a bad thing. Businesses with deferred revenue can convert it to revenue after performing agreed-upon services or delivering products.

What is an example of deferred revenue?

Examples of deferred revenue include an annual gym membership paid in advance, a gift card purchase, or tickets to a future event, such as a concert or sporting event.

How is deferred revenue treated?

Deferred revenue is treated as a liability and is shown on a company’s balance sheet.

How do you record deferred revenue?

Deferred revenue creates an increase in your cash account and an increase in a deferred revenue account, which is a liability.

","Confused by upfront payments? Deferred revenue explains why they're a liability, not income. Learn how it works, avoid misleading financials, and cash flow issues."," $\"coins$ \n

Confused by upfront payments? Deferred revenue explains why they're a liability, not income. Learn how it works, avoid misleading financials, and cash flow issues.

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Are you ready to take your business global? There’s a laundry list of things to do to prepare for cross-border commerce. Arguably, the most important part is your international payment setup: how you’ll get paid from foreign customers or pay international suppliers.

In this article, you’ll learn how international payments work, how they differ from domestic payments, and how to minimize payment fees.

Table of contents

What are international payments?

International payments are financial transactions where the person sending the cash and the person receiving the cash are in different countries. International payments are also known as cross-border payments.

Businesses use international payments to expand their market reach and manage their global supply chain. That might involve sourcing inventory from Hong Kong or expanding a customer base by selling to customers in Singapore.

International payments often involve the conversion of one country’s currency into another. For example, a US-based ecommerce store that sells in Singapore needs an international payment option that converts the US dollar to the Singapore dollar.

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Differences between international and domestic payments

Domestic payments and international payments are similar because they both involve the transfer of funds from one party to another. But the similarities end there. Here are some key differences between international payments and domestic payments:

Processing time
Foreign currency exchange
Foreign exchange risk
Regulatory compliance
Intermediaries
Transaction charges

Processing time

Domestic payments are faster than international payments because they use a simpler infrastructure within a single country’s financial system. You can transact between banks with established relationships, eliminating the need for intermediary banks often used for international money transfers.

Domestic payments also deal with the same currency, eliminating the need for conversion. This requires less scrutiny for money laundering and illicit transactions.

Foreign currency exchange

Domestic payments are made in a single currency and don't involve currency conversion. However, international payments often involve at least two currencies, requiring currency conversions. These currency conversions take time and money. Banks will typically use a real-time mid-market exchange rate and then add on markup for their profit.

Foreign exchange risk

Currency conversion in international payments comes with foreign exchange risk (FX risk). FX risk is the chance of losing money when converting currency because of exchange rate fluctuations.

Suppose your ecommerce company owes a Japanese supplier 1,000 yen for inventory you ordered last month. When you placed the order last month, the exchange rate was $1 = 100 yen. Therefore, you owed $10 (¥1,000 ÷ ¥100) last month.

But instead of paying the supplier last month, you’re paying today. And the exchange rate is $1 = 95 yen. Now you’ll owe $10.53 (¥1,000 ÷ ¥95). Waiting a month to pay your supplier costs you an additional $0.53.

On the other hand, you could save money with FX risk. Assume that today's exchange rate was $1 = 110 yen. You would pay $9.09 (¥1,000 ÷ ¥110), saving $0.91.

Regulatory compliance

While local regulations govern domestic payments, international money transfer is governed by the rules of the originating country and the receiving country.

Countries can have different compliance requirements for:

Anti-money laundering
Customer due diligence, also known as Know Your Customer (KYC)
Imposed sanctions
Tax reporting

Intermediaries

Domestic payments often involve just two banks in the same country: the sending and receiving banks. International payments, however, involve banks from multiple countries that aren’t directly connected. Intermediaries bridge this gap. They include correspondent banks and intermediary banks that ensure recipients receive funds in their local currency.

The drawback of intermediaries is that they slow down processing times, increase costs, and may lack transparency on exchange rates used and fees charged.

Transaction charges

Domestic payments are often cheaper than international payments. Examples of charges for international payments are:

Transaction fee from your bank
Intermediary bank fee
Foreign exchange fee markup
Wire transfer fee

Types of international payments

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	Wire Transfer	Online Payment Platforms	Money Orders	FX Brokers	Cryptocurrency
Cost	High fees	Fees vary but are lower than wire transfers	Currency conversion fee and issuance fee	Commission fee and markup on exchange rate	Transaction fees vary by currency
Transaction Limitations	No fixed upper limit	Varies depending on user verification status	Lower transaction limits	Ranges from a few thousand to millions	Limits vary by platform
Speed	Often completed the same day or the next	Quicker than money orders, but slower than wire transfers	Can take several days or even weeks	Can be faster than wire transfers	Some cryptocurrencies can process transactions in minutes
Special Requirements	Recipient's bank account information	Account creation is required, and a bank account or credit card may be linked	Must visit a physical location and fill out a form	Large transactions may require additional documentation	A cryptocurrency wallet and an understanding of cryptocurrency transfers
Security	Bank-level encryption	Robust security measures, but vigilance is still important	Anyone with a money order can cash it	Considered secure due to broker regulations	Considered high risk

\n\n

Wire transfers

A wire transfer is an electronic payment that moves money from one bank account to another. Most people prefer wire transfers for sending large amounts of money because they are reliable, fast, and secure. That said, banks tend to offer subpar exchange rates that eat into your profits when converting international payments into your home currency.

Fees may not always be upfront, especially with intermediary banks involved. Exchange rates may also not be the most competitive.

Online payment platforms

Online payment platforms are digital intermediaries that transfer money between buyers and sellers in online transactions. Examples of online payment platforms include PayPal, Stripe, and Shopify Payments—the payment gateway specifically designed to help Shopify merchants process online and in-person payments through a single platform.

Start accepting payments fast with Shopify Payments

Skip lengthy third-party activations and go from setup to selling in one click. Shopify Payments comes with your Shopify plan, all you need to do is turn it on.

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International money orders

International money orders aren’t electronic and act like checks. With them, cash is withdrawn from the sender’s bank account immediately, not when the recipient eventually cashes the money order.

The downside of international money orders is the lower transaction limits. It can also take several days for money orders to clear, and you’ll need to visit a physical location (such as a bank) to fill out the form.

Foreign exchange brokers

A forex broker (FX) is a financial services company that provides individuals access to the foreign exchange market.

While banks also convert foreign currency, forex brokers offer more competitive exchange rates when you want to transfer money internationally. They can also handle larger transactions and offer lower fees than traditional wire transfers, but you’ll need to contact an FX broker to assist.

Cryptocurrency transfers

While not accepted in all countries, cryptocurrency transfers are often cheaper and faster than traditional banking systems. Examples of crypto payments include Bitcoin, Ethereum, and Dogecoin.

Payouts for this type of international payment can be extremely fast, depending on the cryptocurrency you've chosen. The downsides are that you'll need a crypto wallet, exchange rates can fluctuate dramatically, and they're rife for scams.

What can you use international payments for?

A business might use international payments for the following transactions:

\nBuying products and services: International payments are useful when a business wants to buy a product or service from abroad, like purchasing inventory from a German supplier in Euros.
\nPaying international employees and contractors: International payment methods help businesses pay their international employeesand contractors.
\nAcquiring assets: A business can buy many assets locally. However, some equipment and assets are better sourced from abroad for reasons that can range from cost to quality.
\nPaying for travel and expenses: When an employee travels out of the country for business, their company may choose to pay these expenses with an international payment.
\nMaking donations: Humans love to lend a helping hand. Your business may want to contribute to a cause it holds dear, whether education, disaster relief, or human rights. If you choose an international charity, your business will need to use an international payment method to donate money.

Challenges in international payments

International payments are efficient for business operations, but they come with challenges. Common challenges associated with international payments include:

Regulatory hurdles

Regulatory frameworks, including data privacy laws, are numerous, complex, and sometimes even conflicting. Anti-money laundering laws can be difficult to navigate. Some businesses may consider these hoops needlessly frustrating and dial back on their international payments.

Fraud and security concerns

Because of their complex nature and involvement of multiple parties, international payment platforms are vulnerable to fraud—from theft of customer information to unauthorized transactions and account takeovers. Online payment platforms like Shopify have elaborate fraud prevention measures to combat these risks.

Best practices for managing international payments

Understand local payment preferences

Doing business internationally means you’ll need to understand local payment preferences.

Aligning with local payment preferences can lead to cost savings and improved business relationships.

Let’s put that into practice and say you’re buying inventory from suppliers in China. Alipay and WeChat are the most popular payment methods in this country. Combined, they account for 90% of Chinese mobile payments. It’d make sense to create an account with either mobile wallet app and pay in your supplier’s preferred method of payment, rather than forcing them into your way of working.

Use efficient payment gateways

A payment gateway is the technology you’ll need to securely collect and transmit payment information through your ecommerce site. Yours should be efficient, secure, and reliable. Evaluate all gateways while considering factors such as transaction costs, speed, and security.

Don’t limit yourself to just one or two options to consider. There are many options, including Shopify Payments, where merchants are not charged third-party transaction fees for orders that are processed through Shop Pay, Shop Pay Installments, and PayPal.

With Shopify Payments, you have the ability to use different payment gateways for different payment types. You can have a payment gateway that accepts credit cards, a PayPal payment gateway, an alternative payment gateway, and a manual payment gateway. If you’re interested, you can set up additional payment gateways by using these instructions.

\n\n

Ensure compliance and security

Regulatory requirements differ from country to country. Non-compliance can result in costly fines and damage to your company’s reputation. Stay informed about banking regulations in your markets and partner with a payment processor that has robust compliance procedures.

Optimize for mobile payments

Ensure your website and payment gateway are responsive and mobile-friendly. Consider offering mobile wallets like Apple Pay or Google Pay as payment options for international customers who prefer to pay in their own currency.

Provide transparent pricing and fees

You don’t want your customers to complain about hidden costs or higher-than-expected transaction costs. Hidden fees are the reason behind 47% of abandoned carts, so clearly display the total cost of an order and consider allowing multiple currency options so customers can see the price in their preferred currency.

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\nDiscover Managed Markets\n

International payments FAQ

How do I make an international payment?

You can use a bank where you have your checking account to make an international payment. Or, you can open an account with an online payment platform that specializes in money transfers, like Wise or Western Union.

What is the best international payment method?

The best international payment method depends on the countries involved and the type of transaction. There are many options, but the common ones include:

Wire transfer
Online payment platform
Cryptocurrency
International money order
Foreign exchange broker

How does international pay work?

International pay occurs when the person sending money and the one receiving it are in different countries. It can be a complex process that starts with you making the payment, the financial institution making the currency exchange, and the transaction being settled.

How can I avoid international payment fees?

Avoiding international payment fees starts with choosing the right payment method. For example, if you’re sending money to a friend, a money order might be the cheapest option. If you’re sending a large amount of money, working with an FX broker might be cheaper than a traditional bank.

If you make regular payments, such as for supplier payments or salaries, plan them in advance. Some services offer better rates and lower fees for scheduled transfers compared to last-minute ones.

","Easily manage international payments for your business. Learn about methods, fees, and best practices for accepting and making payments globally."," $\"a$ \n

Easily manage international payments for your business. Learn about methods, fees, and best practices for accepting and making payments globally.

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Imagine if when a customer gets to the checkout page of your ecommerce site, they had to email you their credit card number so you could process the transaction. That wouldn’t be very convenient for either of you.

But thanks to payment APIs, checkout experiences are much safer and more efficient. A payment API is a more secure, practical interface that allows businesses to accept payments online.

This article explains the different payment APIs available, the factors to consider when choosing the right one, and the top providers in the market.

Table of contents

What is an API?

API, short for Application Programming Interface, is a piece of computer code that helps two software programs exchange information.

Most commonly, APIs allow one program to work on another. For example, when you see a map of a company’s headquarters on their website, they might be using a Google Maps API to embed that map without you having to exit the site to visit Google Maps.

Here’s another way to think of an API:

When you order at a restaurant, the kitchen staff is one software program, and you as the customer are the other software program. You don't directly tell the kitchen staff what you want to eat, and they don't follow up if you have questions about your order.

The waitstaff acts as the API to get the kitchen your food order and to deliver your food when it's ready.

What is a payment API?

A payment API is a connection to a payment gateway and/or processor that lets apps and online stores accept and process payments. It helps you manage business transactions, accept various forms of payment, and automate the billing process, such as through subscription APIs.

A payment API's core function is to process payments efficiently and securely. Rather than having to visit a separate website to complete the checkout, a payment API can enable customers to safely transmit payment information and lets stores process those payments all within one interface.

A payment API that connects to a payment processor makes it easy for stores to accept multiple payment methods like credit cards, ACH transfers, and digital wallets. They are essential for ecommerce stores and other types of businesses that rely entirely on online payments.

Start accepting payments fast with Shopify Payments

Skip lengthy third-party activations and go from setup to selling in one click. Shopify Payments comes with your Shopify plan, all you need to do is turn it on.

\nDiscover Shopify Payments\n

How do payment APIs work?

Payment APIs provide a built-in interface on your website to capture customer payment information and transmit it for authorization and settlement, ensuring smooth and secure transaction processing.

The specifics can differ a bit based on whether the payment API is for a payment gateway, a payment processor, or an integrated solution, but the process generally looks like this:

\n Initial payment request: When customers make a purchase on a website or app, they enter their payment information (like credit card details) into a secure form provided by the payment API.
\n Secure data transmission: The payment API encrypts and securely transmits the customer’s payment information to the payment gateway or payment processor.
\n Payment authorization: The payment gateway sends the payment details to the payment processor, who then checks with the issuing bank or card network (like Visa or MasterCard) whether there are sufficient funds and no security flags so the payment can be authorized.
\n Transaction response: The payment processor receives a response from the bank or card network whether the transaction was approved or declined and generally passes that information on to the payment gateway.
\n Communicate outcome: The payment API receives the response from the payment gateway and relays it to the website or app that notifies the customer whether the payment was successful.
\n Funds settlement: Upon approval, the bank reserves the money in the customer’s account and then transfers it to the merchant’s account. This process can take a few business days.

Types of payment APIs

Payment APIs come in different shapes and sizes. The following are some common types:

Transaction APIs
Subscription APIs
Tokenization APIs
Payout APIs
Preauthorization APIs

Transaction APIs

As the name implies, transaction APIs are used to complete payment transactions. They help customers make several payment-related requests, including:

Initiating payments
Refund requests
Canceling payments

Transaction APIs are common for ecommerce payment processing.

Subscription APIs

Subscription APIs help businesses automatically bill customers at regular intervals.

The subscription API could initially capture the billing details and approve the subscription. It could then communicate with other types of operational APIs to handle future orders, such as to make sure your inventory reflects the next shipment for that subscription

For companies with recurring payments, subscription APIs are indispensable.

Tokenization APIs

Tokenization is the masking of data to create a disguised version called a token.

Tokenization APIs disguise sensitive payment data, like credit card numbers, when transmitted to and from payment gateways and processors. A tokenization API can also be included in a transaction API.

Payout APIs

Payout APIs send disbursements to multiple payees at once to efficiently manage bulk payments, like to freelancers, suppliers, or payroll.

Payout APIs handle the complexities of transferring money to different accounts, in multiple currencies, and in multiple regions while complying with financial regulations and security standards.

Preauthorization APIs

Preauthorization APIs temporarily hold funds on a customer’s card or account to verify a customer's ability to pay before releasing products or rendering services.

This is useful in scenarios where the final purchase amount might vary or if you need to verify the payment method is valid before doing work.

How to choose a payment API

Your payment API affects customer experience, cybersecurity, and overall operational efficiency.

Consider these factors when choosing your payment API.

\nSecurity: APIs are often a common target of cyberattacks. Ensure the payment API complies with the highest security standards, including the PCI DSS (Payment Card Industry Data Security Standard). The API should include encryption, tokenization, and fraud detection to allow for secure payment processing.
\nPayment methods: Look for an API that supports a wide range of online payment methods. If your customers can’t pay with their preferred credit card or digital wallet, for instance, they might abandon their carts, thereby costing you revenue.
\nOngoing technical support: A payment API should provide ongoing technical support, including dedicated support staff to help with troubleshooting and API updates.
\nFees and pricing: Understand the fee structure, including transaction fees, monthly subscription fees, and any hidden costs. While you might not want to make your decision on pricing alone, considering the importance of handling payments, you don’t want to overpay either.
Integration and compatibility: Consider how well the API integrates with your current ecommerce platform and other systems like inventory management and accounting software. APIs should be convenient for both customers and store owners.
\nReliable uptime: Payment APIs should have minimal downtime and outages. Otherwise, you could miss out on sales.
\nUser experience: Think about how the API will impact your customers. Features like one-click payments, quick checkout processes, and reliability contribute to customer satisfaction.

\n\n

Top payment API providers

1. Stripe

Stripe is another full-service payments provider. While often known for working with ecommerce companies and integrating with hundreds of applications and software, Stripe also offers in-person payment terminals that can be integrated with online sales.

Top features:

Stripe accepts a vast array of electronic payment methods, such as major credit cards, Apple Pay, Amazon Pay, and multiple buy now, pay later options.

Plus, it was designed with developers in mind. To get the most out of Stripe’s APIs, businesses will need access to a team of developers. However, Stripe also offers no-code options for teams without coding experience and advanced security features, including the use of machine learning to spot fraud.

Pros:

Strong international availability
Lots of options for customization
24/7 support by phone, email, or live chat

Cons:

Chargeback fees
International fees
Payouts can take longer than some competitors

2. PayPal

PayPal is a household name in online payments. But it’s not just a payment method, it’s also a processor. Through PayPal’s APIs, you can accept payments on your site through PayPal.

It integrates with many popular ecommerce platforms, such as Shopify, and other software like accounting platforms.

Top features:

PayPal supports over 120 currencies and allows merchants to accept PayPal payments alongside credit card payments.

When PayPal is used as a payment gateway but transactions are processed outside PayPal, the payments company offers a number of other features, like accepting more payment types and offering enhanced security features.

Pros:

Strong international availability
Accepts crypto
Offers option for seller chargeback protection

Cons:

Standard transaction fees are higher than some competitors
Payouts can take longer than some competitors
May charge customer dispute fees

3. Square

Square is a payments service that acts as both a payment gateway and processor. The company also provides hardware, including card readers, which can be helpful for online stores that run pop-up locations.

Top features:

Square offers both pre-built and custom payment APIs. Its APIs integrate with several ecommerce platforms, inventory management systems, and accounting software.

The company also uses machine learning to help spot fraud and provides software tools for integrating online and offline sales.

Pros:

No chargeback fees
No direct international fees
Fast payouts

Cons:

Limited international use. Currently only supports sellers in the US, Canada, Australia, Japan, the UK, Ireland, France, and Spain
Limited alternative payment methods accepted through direct integration

4. Authorize.net

Authorize.net, now owned by Visa, is one of the oldest payment gateways in the ecommerce world. However, the company does not act as a traditional payment processor itself, but it works with others.

Top features:

Some of Authorize.net’s top features include easy support for recurring billing and storage of customer data to facilitate repeat purchases. The company also has a number of advanced fraud protection measures.

Pros:

Long track record
Great for recurring billing
Flexibility to choose your own payment processor, which could be helpful to some businesses

Cons:

May need your own merchant account through another service, depending on the plan
Limited international availability for sellers. Currently only available for merchants in the US, Canada, UK, Europe, and Australia.
Pricing may not benefit all businesses, depending on the payment processor

Choose the right payment API for your business

APIs simplify payment acceptance and processing for ecommerce companies, ensuring smooth, secure transactions. Some payment APIs are pre-built, but others need to be customized to fit your site, so you need to pick the right one.

Payment providers to which these APIs connect vary a lot based on things like payment methods accepted, fees, and payout processing speed. Get the right payment API for your ecommerce store that integrates easily, prioritizes security, and fits your budget.

Start accepting payments fast with Shopify Payments

Skip lengthy third-party activations and go from setup to selling in one click. Shopify Payments comes with your Shopify plan, all you need to do is turn it on.

\nDiscover Shopify Payments\n

Payment API FAQ

What are the benefits of a payment API?

Payment APIs create a minimal-friction checkout experience that integrates directly into websites and apps. They allow businesses to accept a wide range of payment methods securely and at scale.

Are payment APIs free?

Payment APIs are often free in terms of there not being an extra charge for the computer code needed to connect to a payment gateway and/or payment processor. However, payment gateways and payment processors do charge fees, such as a percentage-based transaction fee along with a flat per-transaction fee.

What is the best payment gateway API?

Payment gateway APIs have distinct features and benefits. There is no universal best one. When analyzing your choices, consider your business size and transaction volume, technical expertise, accepted payment methods, and security features.

Is PayPal an API?

PayPal is a payments company that offers a payment processing API to integrate the PayPal checkout experience into other websites and apps.

How do I make a payment API?

Building a payment API from scratch is a complex coding process that typically requires expertise in payment processing, security, etc. However, many payment companies offer pre-built APIs and software developer kits (SDKs) that can be used to create custom APIs.

","Payment APIs simplify payments and boosts sales. Learn how to choose the right API for your business."," $\"a$ \n

Payment APIs simplify payments and boosts sales. Learn how to choose the right API for your business.

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Running a successful business means paying attention to what's happening behind the scenes.

Whenever you make a sale, buy inventory, or pay employee wages, a business transaction is born. To make accurate business decisions and get a clear picture of your company's cash flow, you need to understand how these transactions work.

Ahead, you'll learn what business transactions are and how they're recorded in the company's books.

Table of contents

What is a business transaction?

A business transaction is an economic event between two or more parties that involves the exchange of goods, services, or money. To document and manage business transactions effectively, keep accurate records, use invoicing software, and ensure all agreements are clearly detailed to avoid disputes.

Key features of business transactions include:

The buyer and seller must agree on the terms of the exchange

The buyer makes an offer for the goods or services, and the seller accepts the offer. An example of this is when you buy a car. You make an offer of $10,000 to purchase a Honda Civic from a dealer, and the dealer accepts your offer. However, the order of the offer and acceptance can also be switched.

Think of shopping at the grocery store. The grocer offers to sell you a bag of rice for $1.99 and you agree to purchase it by checking out. These are both considered business transactions.

NOTE: Unlike the examples above, the exchange of goods or services doesn’t have to occur immediately.

Suppose your business entity is accepting preorders for a new product you’re launching in a few months. A customer agrees to purchase one and pays you now even though you won’t deliver the product until sometime later. This is a sales transaction.

The buyer must offer something of value to the seller

This is often cash. But it could also be goods or services, which is known as a barter transaction. A barter transaction example is when you provide a gift card from your ecommerce store to your tax accountant for preparing your annual tax return.

The key is that something of value must be offered by each party.

Let’s look in detail at a hypothetical ecommerce example. Suppose your ecommerce store sells Samsung cell phones. You make an offer to a wholesaler to purchase 100 Samsung Galaxy S24 phones for $300 each.

Does this qualify as a business transaction?

Not yet, because the wholesaler hasn’t accepted your offer. The wholesaler rejects your $300 per piece price and counters with $325. You agree this is still a reasonable offer and agree to purchase 100 phones at $325 each.

Now, we have a business transaction. The wholesaler made an offer, and you accepted. Both of you offered something of value—for the wholesaler it’s phones and for you it’s cash.

As we mentioned earlier, once a business transaction occurs, it must be recorded in the company’s financial records, depending on the type of business transaction.

Manage your money where you make it with Shopify Balance

Shopify Balance is a business account that lets you manage your business’s money from Shopify admin. Pay no monthly fees, get payouts up to seven days earlier, and earn cashback on eligible purchases.

\nDiscover Shopify Balance\n

Types of business transactions

Business transactions are recorded according to their type and category. There are four main types:

1. Sales transactions

All businesses exist to sell goods or services. A sales transaction happens when your business sells something to a buyer. That something could be a physical item, an intangible good (like software), or a service.

As we’ve seen, these exchanges can be for:

Cash now (cash transactions)
Cash later (credit transactions)
Items or services of value (barter transactions)

Let’s get specific with an example. Assume a pastry company offers to sell a major hotel brand a case of its delicious macarons for $100 to give to guests. And the hotel accepts its offer.

This creates a sales transaction for the pastry company because it’s offering something of value (a case of macarons) and the hotel accepted by offering something of value (cash).

But what if the pastry company offers the case of macarons for a free one-night stay at the hotel? This is still a sales transaction because both parties agreed on the transaction details and both offered something of value.

2. Purchase transactions

In business, purchase transactions occur when a company buys goods or services. Like sales transactions, these purchases can be for cash or something of value.

Going back to the pastry company example, when the company buys sugar to make the macarons, a purchase transaction occurs and is recorded in the company’s financial books.

Purchase transactions also happen when the pastry company buys a MacBook to help with recordkeeping, a van to help with local deliveries or new baking equipment.

A business records a purchase transaction at the earlier of two events:

\nPayment: when it pays for the goods or services it ordered
\nReceipt: when it receives the goods or services

Let's consider some examples.

If the pastry company orders a MacBook for $1,500 but hasn’t paid for or received it, there’s no purchase transaction, and the bakery shouldn’t record this purchase.

But, if the company orders the MacBook and immediately pays with a credit card, then it has a purchase transaction to record. And, if the pastry company orders the MacBook and receives it, but hasn’t paid for it, it will record this as a purchase transaction.

If the pastry company offers a dozen macarons to a professional photographer for product photos for the company’s website, this is also a purchase transaction.

3. Payment transactions

Contrary to a purchase transaction, which may not include an immediate exchange of cash, a payment transaction is always accompanied by a cash transfer. When a company pays for any business-related item—whether salaries, utilities, office supplies, taxes, or inventory, a payment transaction occurs.

With a payment transaction, the key thing is that there must be a transfer of cash.

4. Receipt transactions

A receipt transaction occurs when a business receives money for any business-related reason. This could be for goods sold, services rendered, assets disposed of, or a tax refund—anything that leads to an increase in cash.

A receipt transaction differs from a sales transaction. But they are related. Remember that a sales transaction doesn’t always include an immediate transfer of cash. You have a sales transaction when you supply the requested goods or services, even if it’s not paid for immediately.

On the flip side, for a receipt transaction, a business must receive cash. So when you get paid by your customer for that sales transaction, you’ll have a receipt transaction to record.

How to record business transactions

All business transactions must be recorded in a company’s financial records.

This process is known as bookkeeping. Inaccurate bookkeeping can create a host of problems for a business owner, including solvency issues and inaccurate tax reporting.

The bookkeeping of a business is like a flow chart and follows these steps:

Identify when a business transaction happens
Quantify the financial impact of the transaction
Record the transaction
Prepare financial statements

Step 1: Identify when a business transaction happens

Understand your business to know when a business transaction occurs.

Perhaps an electronics ecommerce store receives 100 units of Samsung phones it ordered, a bakery receives money for the pastries it sold, or a business pays employees’ salaries.

Step 2: Quantify the financial impact of the transaction

Review relevant documents, like invoices, receipts, or contracts, to determine which financial accounts are affected and by how much.

Step 3: Record the transaction

Post the transaction, via a journal entry, into the financial ledgers. Include details such as the transaction date, items purchased, and the amount paid.

Step 4: Prepare financial statements

Financial statements are prepared periodically, often monthly, quarterly, and annually.

A business prepares its income statement, to know how much profit it earned or how much loss it incurred. Companies also prepare their balance sheets to know their assets, liabilities, and equity.

Manage business transactions easily with Shopify Balance

Thanks to technology, business transactions are easier to record, monitor, and analyze. And ecommerce businesses can use Shopify Balance to manage their business finances in one spot.

Integrated into your Shopify admin, Shopify Balance:

Has no monthly fees or ACH transfer fees*
Requires no minimum balance
Gets you paid up to seven days earlier than a bank
Automatically sets aside sales tax for you
Syncs with your accounting software
Has a mobile app to manage money on the go
Gives you cash back on eligible purchases
Provides you a complete view of your business’s money

Manage your money where you make it with Shopify Balance

Shopify Balance is a business account that lets you manage your business’s money from Shopify admin. Pay no monthly fees, get faster payouts, and earn cash rewards****.

\nDiscover Shopify Balance\n

Shopify partners with Stripe Payments Company for money transmission services and account services with funds held at Fifth Third Bank N.A., Member FDIC. Shopify Balance Visa® Commercial cards are powered by Stripe and issued by Celtic Bank pursuant to a license from Visa U.S.A. Inc.

*Shopify Balance has no monthly or ACH transfer fees. Shopify doesn’t charge any ATM withdrawal fees, but you may be charged by an ATM provider.

**Shopify Payments payouts are typically deposited into your Shopify Balance account within 1-3 business days, and no later than 5 business days. Payouts sent to an external bank account usually take over a week longer to process.\n

***Earn up to $2,000 USD cashback on eligible business purchases per calendar year. Learn more.

****\nThis is a reward provided by Shopify and is not interest. The rate is variable and subject to change without notice. The reward accrues daily, and is compounded and paid monthly in the form of a credit to your Balance account. ACH limits may apply. View Reward Terms.

Business transactions FAQ

What are the 4 types of transactions with examples?

The four business transactions are:
Sales transactions: A sales transaction occurs when a business delivers a good or provides a service either for cash or for an item of value.
Purchase transactions: A purchase transaction occurs when a business buys a good or service for cash or an item of value.
Receipt transactions: Receipt transactions take place when a business receives money for any business-related reason, including for goods supplied, services rendered, or assets disposed of.
Payment transactions: Payment transactions occur when a business pays cash for any business-related reason, including buying goods, receiving services, or acquiring assets.

What are the elements of a business transaction?

The elements of a business transaction include:
An agreement to exchange goods or services between the buyer and seller for cash or item of value
The exchange of the goods or services
The exchange of cash or the agreed-upon item of value

How do you write a business transaction?

Business transactions are written—or recorded—as journal entries in the financial ledgers of the company. Journal entries include the transaction details like the transaction date, items bought or sold, and the amount of money received or paid.

What is business transaction flow?

Business transaction flow tracks a transaction's journey from start (e.g. customer order) to finish (appearing in the company’s financial statements).

","Understand how transactions work and the different types, so you can make smarter choices and have a clear financial picture."," $\"a$ \n

Understand how transactions work and the different types, so you can make smarter choices and have a clear financial picture.

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Solvency, just like profitability, is a financial metric every business owner should be familiar with.

Financial solvency is required for long-term survival. If a business is insolvent, it can find itself filing for bankruptcy and going out of business.

To keep your ecommerce business financially sound, learn what solvency means, how it works, and some practical strategies your business can use to improve its financial solvency.

Table of contents

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What is solvency in simple terms?

Solvency is a financial metric that evaluates a company’s ability to meet its long-term financial obligations. In business, debt is often a double-edged sword. While it can be an exceptional financial catalyst, it can also lead to a business’s downfall if poorly managed.

But solvency is sometimes confused with liquidity. While the two are similar, they are not the same.

Liquidity vs. solvency

Liquidity measures a company’s ability to pay its short-term financial obligations. Solvency measures a business’s ability to meet its long-term financial obligations.

A liquidity problem occurs when a company cannot pay its short-term liabilities, like employee wages or supplier invoices, using cash on hand and outstanding customer receivables. Liquidity can easily become a concern for an ecommerce company.

For example, assume a company makes large inventory purchases in Q1 to prepare for a busy summer selling season. The company may face liquidity issues in Q2 because a large chunk of its cash is tied up in inventory that won’t sell for several months. This leaves little cash coming in to cover ongoing expenses like rent, wages, or order fulfillment.

On the flip side, a business experiences a solvency problem when it can’t pay its long-term liabilities, like loans and mortgages, even if it sells all of its assets.

When the total of a company’s current assets (e.g., cash, inventory, receivables, equipment, etc.) is less than its total liabilities, the business has a solvency problem. While a liquidity issue can be frustrating and can slow down operations, a solvency problem can be dire.

Here’s how to visualize the difference between liquidity and solvency.

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	Liquidity	Solvency
Time span	Within one year	Long-term financial outlook
Ability measured	To pay current financial obligations	To meet current and future financial obligations
Assets considered	Assets that can easily convert to cash	Total assets
Liabilities considered	Debts due within one year	All debts
Impact	Short-term cash flow problems	Potential bankruptcy
Example	Company with high inventory but low sales	Company with high debt and declining sales

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How does solvency work?

Because solvency is a key financial benchmark, merchants need to know if their businesses are solvent. But how?

The easiest way to determine if a business is solvent is to sum up its total assets and total liabilities and then subtract its total liabilities from its total assets. To calculate solvency, use this formula:

Solvency = Total Assets – Total Liabilities

For instance, suppose an ecommerce store’s assets include:

\n\n\n

\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n

Ecommerce Shop Assets	Dollar Value
Cash	$300,000
Inventory	$450,000
Software	$200,000
*Total assets*	*$950,000*

\n\n
\n

And assume its liabilities are:

\n\n\n

\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n

Ecommerce Shop Liabilities	Dollar Value
Vendor/supplier invoices	$100,000
10-year bank loan	$500,000
*Total liabilities*	*$600,000*

\n\n
\n

Since the company’s assets exceed liabilities by $350,000, this company is solvent since it has an extra $350,000 to cover its total liabilities.

It also helps for business owners to understand these three solvency ratios.

Debt-to-equity ratio

The debt-to-equity ratio measures how a company finances itself with debt (loans and payables) compared to its own money (equity). It reflects the company’s leverage. In this calculation, debt is the numerator and equity is the denominator. To calculate debt-to-equity, use this formula:

Debt to Equity = Total Debt ÷ Total Equity

A higher ratio, typically over 2, should be a concern to an ecommerce entrepreneur. A debt-to-equity ratio of 2 means that for every $1 of equity, there is $2 of debt. This is when you can creep into solvency issues.

The ideal debt-to-equity ratio varies widely by industry. For example, businesses in capital-intensive industries, such as airlines, have higher debt-to-equity ratios. But technology and healthcare companies have lower debt-to-equity ratios.

Let’s look at an example from popular ecommerce company eBay’s December 31, 2023 balance sheet.

Ignore all the words and numbers. Only look at the items blocked in red and blue. These are the two numbers needed to calculate eBay’s debt-to-equity ratio.

As of December 31, 2023, eBay had a debt-to-equity ratio of 2.38 ($15,224 ÷ $6,396). As an established ecommerce company, this ratio wouldn’t raise solvency concerns. But for newer ecommerce businesses, this would warrant ongoing monitoring.

Interest coverage ratio

Another way to know if your business is solvent is to calculate its interest coverage ratio.

The interest coverage ratio measures a company’s ability to cover its interest expense on its debt. It tells you how easily the company’s current earnings can cover the interest expense; hence the term “Interest Coverage.”

You can calculate your interest coverage ratio by dividing your company’s earnings before interest and taxes (EBIT) by its interest expense. Use this formula to calculate interest coverage ratio:

Interest Coverage Ratio = EBIT ÷ Interest Expense

EBIT shows you how much profit your business made from its core operations before considering extra expenses like income taxes and interest.

A low-interest coverage ratio suggests a company may have difficulty paying its interest expense. But a higher ratio means the business has more wiggle room to pay its debt obligations.

What interest coverage ratio should ecommerce businesses aim for? A company with consistent revenues should aim for a minimum interest coverage ratio of 2.

Let’s look at another real-world example from the ecommerce brand Etsy. Again, ignore all the words and numbers. Only look at the items blocked in red and blue. These are the two numbers needed to calculate eBay’s interest coverage ratio.

As of December 31, 2023, Etsy’s interest coverage ratio was a solid 19.9 ($279,841 ÷ $14,042). This is a strong financial position because it means that for approximately every $20 Etsy makes, it spends only $1 on interest.

Equity ratio

Another financial metric you use to evaluate your company’s solvency is the equity ratio.

Business owners and analysts can evaluate a company’s solvency by analyzing its debt using the debt-to-equity ratio or the interest coverage ratio. But you can also evaluate a company’s solvency by reviewing its equity level.

Equity is how much of your business you own after deducting what the company owes to others. The idea behind the equity ratio is that if equity is high, then debt will correspondingly be low. The formula for the equity ratio is total equity ÷ total assets.

Let’s go back and look at eBay’s balance sheet and calculate its equity ratio. Remember to only look at the items blocked in red and blue. These are the two numbers needed to calculate eBay’s equity ratio.

As of December 31, 2023, eBay’s equity ratio was 0.295 ($6,396 ÷ $21,620).

An equity ratio below 1.0 is worthy of attention because it means the company has more debt than equity. While this might not be a problem, it’s worth monitoring.

Factors influencing a company’s solvency

Monitoring your company’s solvency helps ensure its long-term survival and provides peace of mind to you as a business owner.

Factors that affect solvency can be broken down into three categories:

Financial management
Market factors
Operational issues

Financial management

Poor financial management can lead to insolvency, and inefficient inventory management can drain cash flow. Overstocking slow-moving products ties up working capital, but understocking can lead to lost sales.

Keeping a close watch over sales trends, including seasonality and customer purchasing patterns, can help with under or overstocking. Solvency can be traced back to profitability. A company consistently generating healthy profits has a greater ability to meet debt obligations and remain solvent.

Market factors

Economic conditions beyond your control can lead to solvency problems. For example, the government can change its tax regime, import or export policy, or regulatory requirements.

Staying ahead of the competition, identifying changes in customer preferences, or recognizing industry trends can help your business stand out and attract new customers and increase sales.

Operational issues

Your ecommerce company’s operations are the backbone of your business. Slow order fulfillment and unreliable shipping can damage brand loyalty and lead to lost sales and reduced cash flow.

Ensure your marketing campaigns are designed effectively. A poorly designed campaign that cannot generate a good return on investment can eat into cash flow. Rapid expansion of product lines or entering a new category space that is not well thought out can also quickly deplete cash.

Other factors that can affect solvency include technological changes, natural disasters, and poor leadership.

Strategies for improving solvency

Solvency is often a life-or-death issue for a business. That means scrutinizing your solvency metrics can be life-saving.

If you’re worried about solvency and want to shore it up a bit, consider the following strategies.

Improve your profits

There are two ways you can increase your profits: increase sales or reduce costs. Typically, you will start by reducing costs because it's the easiest and can give you results in days.

Consider negotiating better prices with suppliers and shipping vendors. But don’t overlook the need to increase sales. Cutting costs can only do so much to improve a company’s financial health. Consider dynamic pricing models where prices adjust based on demand, competition, and customer behavior.

Restructure your debts

Before risking default, consider restructuring your debts.

Restructuring debts that lead to lower interest rates or extended repayment schedules can give business owners breathing room as they figure out how to put their business operations on a more sustainable track.

Manage inventory efficiently

Review your inventory management techniques to avoid over- and under-stocking. If you haven’t already, create procedures to prevent product damage to reduce waste and shrinkage. Ensure you are completing regular inventory audits to identify any issues with inventory storage.

Securing your future as a business owner

While you should know whether your company is earning profits, you should also assess whether it will continue to make profits for the foreseeable future. That’s why solvency, which measures whether a business can meet its long-term financial obligations, is crucial.

The debt-to-equity ratio, interest coverage ratio, and equity ratio can help entrepreneurs evaluate whether their companies are solvent or not.

And if you find your solvency metrics aren’t stellar, you may want to explore restructuring your debts and cutting unnecessary costs.

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Solvency FAQ

What is solvency in finance?

Solvency is a financial measurement that evaluates a company’s ability to pay its long-term financial obligations.

Is solvency a good thing?

Solvency is a good thing because insolvent companies go out of business.

What is an example of solvency?

A solvent company has reliable sales that exceed costs that allows it to keep operating in the long run. An insolvent company has high expenses combined with low or declining sales, making it difficult to meet its financial obligations.

Are solvency ratios the same for every company?

No. Solvency ratios vary from industry to industry. The overall aim is to have more assets than liabilities. But how much more will depend on the company.

","Dive into solvency to understand why it’s important and how it’s measured. Learn strategies to keep your business running for the long term."," $\"a$ \n

Dive into solvency to understand why it’s important and how it’s measured. Learn strategies to keep your business running for the long term.

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What retail accounting really is

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When to use retail accounting

Limitations and drawbacks of retail accounting

Retail vs. cost accounting for inventory

How to implement retail accounting into your store

Tools for retail accounting

Shopify POS

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Stocky

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Retail accounting FAQ

What is a retail accountant?

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What is a credit card float in finance?

Example of a credit card float as debt

Example of a credit card float as an interest-free line of credit

How does a credit card float happen?

Cons of allowing a credit card float

Risks financial instability

Creates a cycle of debt

Potential for increased spending

Impacts credit utilization

Interest and fees risk

Should you “Ride the Float”?

Options to cover expenses without doing a credit card float

Cash advance

Invoice factoring

Business loan

Working capital

Business line of credit

Other types of floats in finance

Cash float

Disbursement float

Collection float

Net float

Stay free of credit card floating

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Can credit card float lead to debt accumulation?

How can I recognize if I’m relying on a credit card float?

What is revenue recognition?

How revenue recognition works

Cash accounting

Accrual accounting

International standards

The 5-step revenue recognition model

Step 1: Identify the contract with the customer

Step 2: Identify the contract’s specific performance obligations

Step 3: Determine the transaction price

Step 4: Allocate the transaction price to distinct performance obligations

Step 5: Recognize revenue when you fulfill each performance obligation

Types of revenue recognition

Digital subscriptions (SaaS)

Physical subscriptions

Ecommerce

Installments

Digital goods and products

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Revenue recognition FAQ

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Transactions affecting profits, but not cash flow

Transactions affecting cash flow, but not profits

What is cash flow?

What are the types of cash flow?

Operating cash flow

Investing cash flow

\nFinancing cash flow

What is profit?

What are types of profit?

Gross profit

Operating profit

Net profit

Improve your cash flow and profits in 2024

How to improve cash flow

\n
Financing cash flow