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Computer Retailer – Accounting Methods

Author: Larry Chester

There is a lot of money to be made selling online. But understanding your company’s profitability is critical to making the right decisions. Confusion over cash-versus-accrual reporting creates continuing questions for business owners. Using the wrong approach can obscure the results with disastrous consequences.

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  • Business – E-commerce computer retailer
  • Location – Southern Wisconsin
  • Sales – $45,000,000 annually
  • Ownership – Two partners

Initial contact –

The business’ part-time CFO was providing financials that didn’t match the reports they received from their accountant. Plus, internal statements showed wild swings in profitability, which meant that until year-end, the owners were never able to truly understand whether they were making money or not.

Significant Findings and Recommendations:

Cash Flow Shortage

The company had very limited cash, large AP balances, and was increasingly relying on their limited credit availability with vendors to purchase products. Since the owners weren’t drawing large salaries, and sales were increasing, questions arose as to the actual use of cash and the company’s profitability.


  • Develop a cash-flow forecast so that the company could understand cash availability and plan on payments to their vendors and the primary lender.
  • Negotiate agreements with their largest vendors for a write-down of amounts due and a payment schedule—or convert their accounts payable balances into term notes with scheduled payments and a balloon payment at the end.
  • Eliminate the sales manager position. This department was managed by one of the owners, so the contribution of the sales manager was not significant.

Financial Reporting

The company’s financial results varied wildly from month to month. Some months had huge profits, which alternated with other months containing huge losses. It was only at the end of the year that they felt that they had any idea as to the actual profit results of the company.


  • Change to accrual basis accounting. The company was currently using cash basis as an accounting method. Since they were delaying payments to their suppliers, and sales were growing, financials showed significant profitability, instead of the mounting losses that were the actual results. Accrued basis accounting would align sales with the actual costs of each sale in the same fiscal period, providing an accurate view of profitability.
  • Identify the actual costs of the items that they were selling. A cursory evaluation showed that many items were being sold at or below cost. Pricing needed a more careful evaluation.
  • Conduct more frequent physical inventory counts. Inventory was a significant item on the balance sheet, and yet a physical inventory was only done at year-end with significant write-offs. Doing weekly cycle counts would remove the heavy staff burden at year-end, and smooth out the posting of variances, allowing for regular operational changes to improve inventory management.


As with many internet retailers, the company had its share of returns. Their channels took credit on their payments for items that they returned to the company. But although these returns showed up on the income statement, there was only a minimum amount of returned stock in the warehouse. In addition, there was little promotion of the returned items for resale.


  • Gain better control over returns coming into the warehouse. Each return should be tracked and entered into the system and matched against the credits taken by their vendors.
  • Build a secondary market for the sale of returned and refurbished merchandise. This provides a basis for reselling the items, even if at cost or less than cost, to recover some of the dollars invested.

Software Evaluation

The company used home-grown software to automatically set item prices. The markets move quickly, and the software automatically changed prices online to keep the company’s sales among the low-priced leaders. Sales volume was high, so sales and cost transactions were posted in aggregate, rather than individually. Therefore, it was difficult to identify the true margin of any individual sale.


  • Do a detailed evaluation of the internal software to verify the accuracy of the algorithms used to price items. Assure that all elements of the cost components were included in the calculation, including all channel costs, freight, and marketing add-ons.
  • Flag any sales that fall below a certain margin level, assuring that management was notified if any pricing started to get too close to cost.
  • Modify the software so that a detailed report was available to allow an analysis of all sales on an individual basis. This way, channels, and products could be evaluated not just by gross sales but profitability as well.

The first red flag that gets raised when a business gets into trouble is a cash shortage. If it’s not a significant change in business that’s causing the shortage, then the ultimate culprit is profitability. Ironically, many businesses look at cash basis financial reports because their accountant has recommended that they use a cash basis for tax reporting. But even though that might be a good decision for taxes, there is no reason to use a cash basis to determine your company’s operating profit on a monthly basis.

Revenue and expenses for each transaction need to be aligned so that they fall into the same period—otherwise, there is no understanding of profitability. In addition, it’s not just the accounting method that is responsible, it’s the timeliness of the entry of AP and AR activity that assures the accuracy of financial reporting. Without the right information, it’s impossible for business owners to know what they should do when questions arise. It’s vital to make sure that the information is timely, accurate, and financially significant.


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