E-commerce is a business model that allows firms and individuals to conduct business over an electronic network. Today, nearly every imaginable product and service is available through e-commerce transactions.
One form of e-commerce business is the one that serves online content in the form of news, proprietary information, and knowledge. Another form of e-commerce is the sale of goods and services through the internet. This may further include business-to-business (B2B) and business-to-consumer (B2C) sales of products and services.
Thus, B2B or B2C e-commerce businesses may require companies to customize their business models in order to capture sales on the internet. Such business models may require companies to build out distribution channels such as warehouses, webpages, and product shipping centers.
Thus, e-commerce significantly changes the way business is conducted. In particular, e-business requires a business to change its organizational structures, the manner in which partnerships and alliances are developed, delivery mechanisms, and regulations under which businesses operate.
These fundamental changes also lead to changes in the accounting records maintained and accounting procedures followed.
In this article, we are going to learn what is a balance sheet and how to analyse balance sheet of an e-commerce business.
What is a Balance Sheet?
The Balance sheet is the statement of the financial position of a business. This is one of the three basic financial statements showcasing elements that directly relate to the measurement of the financial position of a business.
The elements that directly relate to the financial position of a business include assets, liabilities, and equity. All these elements together inform the stakeholders of a business what it owns and owe to the third parties on a specified date. Also, such a financial statement the business entity’s liquidity position and its capitalization.
Note that the balance sheet provides a snapshot of a business’s financial position on a specified date. Typically, it is either the end of a year or a quarter.
Balance Sheet Formula: Accounting Equation
The financial position of an e-commerce business, just like any other business, is affected by the economic resources it controls. Furthermore, the financial position also gets impacted by the entity’s financial structure, its liquidity and solvency, and its capacity to adapt itself to environmental changes.
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For instance, the information about an entity’s economic resources and its capacity to modify such resources helps in determining its ability to generate cash and cash equivalents in the future. Likewise, information about the entity’s liquidity and solvency helps in determining the ability of an e-commerce business to meet its financial commitments as they fall due.
As mentioned earlier, assets, liabilities, and equity are the elements directly related to the measurement of financial position in the balance sheet. Accordingly, the following is the fundamental accounting equation or balance sheet equation or balance sheet formula:
Assets = Liabilities + Owner’s Equity
This means every dollar invested by an e-commerce business towards its assets is either provided by its owners or its creditors.
Thus, the assets of an e-commerce business are the economic resources that provide benefits in the future. These indicate the funds utilized by the business to acquire resources in order to earn profits.
On the other hand, the liabilities and owner’s equity of an e-commerce business are the claims against it. Liabilities refer to the amounts owed by an e-commerce business to outside parties such as banks, creditors, vendors, etc. Whereas owner’s equity refers to the claims that e-commerce business has to receive from outside parties. In other words, the liabilities of an e-commerce business represent the sources through which funds are raised.
How To Analyse Balance Sheet of an E-Commerce Business?
To analyse balance sheet, a business must have an understanding of the components showcased in the financial statement. The following are the various balance sheet items that help in representing the financial position of a business, including an e-commerce business.
An asset refers to a resource that an e-commerce business controls as a result of the events that occurred in the past. Such resources are held by the business as it is expected that the economic benefits would flow to the business in the near future.
An asset’s characteristic of generating future economic benefit means it has the potential to contribute to the flow of cash and cash equivalents to the entity either directly or indirectly. Such potential may take the form of earning profits through the operating activities of a business.
It may also take the form of reducing the production costs as a result of an alternative and efficient manufacturing process in place. In fact, an asset’s characteristic of generating future economic benefit may also take the form of the level of liquid assets that a business has. That is, a business has sufficient liquid assets which can be converted into cash or cash equivalents.
Accordingly, to analyse balance sheet of an e-commerce business, the following are the key components of a balance sheet that one must know.
(a) Current Assets
The Current Assets are the assets that can be consumed or converted into cash within the normal operating cycle of a business or within one year, whichever is longer. The operating cycle of a business refers to the amount of time it takes to buy or produce inventory, sell the finished products and collect cash for the same.
The operating cycle of an e-commerce business is typically low as it takes fewer days to make a sale. For instance, ‘Zapin’ is an e-commerce store selling consumer products. One of the products that it sells is ‘Creme’ body soap. Say it takes ‘Zapin’ 1 day to make a sale, 1 day to collect the amount, and 1 day to make payment to the supplier ‘Creme’, the operating cycle would be 1+1-1 = 1day.
For certain manufacturing businesses, the operating cycle may be one year or more than a year.
Now, the current assets of a business may include cash, marketable securities, accounts receivable, inventories, and prepaid expenses.
The most liquid of all current assets of a business is Cash. Thus, maintaining cash is important for a business in order to maintain its short-term solvency. That’s because cash balance is readily available with the business. A business can use the available cash instantaneously to meet its day-to-day expenses.
In the e-commerce balance sheet, the cash balance is shown as the first item under the current assets on the right-hand side. It typically includes coins, currencies, funds on deposit with a bank, cheques, and money orders.
(ii) Marketable Securities
The next set of current assets is Marketable securities. Marketable Securities refer to the investments that are expected to get converted into cash within a year. Plus, such types of investments are easily marketable. An e-commerce business may invest in marketable securities like treasury bills, notes, bonds, and equity securities.
These investments are the external investments that an e-commerce business may make. There are two reasons why a business may hold external investments. Either it has access to excess cash or accumulates cash to make a larger purchase. Such external short-term investments in equity or debt instruments are held in order to earn capital gain or income.
(iii) Accounts Receivable
Accounts receivables refer to the outstanding amounts that a business’s customers owe to it for the goods and services supplied by the company on credit. These are represented at the net realizable value in the balance sheet of an entity.
The net realizable value of the account receivable is the amount that we get after deducting the bad debt expense from the total outstanding accounts receivable.
In the case of an e-commerce business, the accounts receivable include the net amount related to customers, vendors, and sellers.
Inventories refer to the stocks of goods owned and under the control of the business owner. An e-commerce business typically follows the dropshipping model. In this model, the e-commerce orders are sent to the supplier that manages the stock and handles the order delivery.
In this case, the retailer receives the e-commerce order and sends it directly to the supplier. The supplier is the one who decides on his own the quantities be manufactured. Further, it is his responsibility, and not the retailer’s to maintain stock of goods at all times.
Thus, if the e-commerce store runs on the dropshipping model, it will not include the inventories that are maintained by the third-party supplier. It will only maintain the inventory that it owns and sells it to the end customers.
It is important to note that the items that form a part of inventory are the goods that would be sold in the normal course of business. In the case of merchandising companies, goods available for resale form a part of the inventory. Whereas, in the case of manufacturing firms, goods available as raw materials, work-in-process, and finished goods form a part of the inventory.
(v) Prepaid expenses
Prepaid expenses refer to the operating costs of a business that have been paid in advance. Since such expenses have been paid in advance without receiving the goods or services, they act as assets for the business. That’s because the business is yet to receive the economic benefits.
When expenses are paid in advance, that is, at the beginning of the accounting period, at such a time the cash reduces in the balance sheet. Simultaneously, a current asset of the same amount is created in the balance sheet by the name of prepaid expenses.
(a) Fixed Assets
The Fixed assets of a business are the long-term assets acquired in past transactions for producing goods or providing services. Such assets are not acquired for the purpose of reselling them to earn profit. These assets are non-current assets that are not readily convertible into cash in the normal course of business operations.
This means the fixed assets have a useful life of more than a year. They are either tangible or intangible in nature.
(i) Tangible Fixed Assets
The Tangible Fixed Assets are the physical assets that can be measured. Further, a business entity makes use of such assets to conduct its operations like providing services. Tangible Fixed Assets include Property, Plant and Equipment, and Long Term Investments.
The first head under Tangible Fixed Assets is Property, Plant, and Equipment are the long-term tangible assets that a business acquires for the purpose of carrying out business operations. An e-commerce business’s Property may include land and building that the business owns. It may also include property acquired under build-to-suit lease arrangements when the e-commerce business has control over it during the construction period and finance lease agreements.
Equipment of an e-commerce business may include assets such as servers, networking equipment, heavy equipment, and other fulfillment equipment. Note that the Fixed Assets are stated after considering the accumulated depreciation and amortization.
The Tangible Fixed Assets may also take the form of long-term investments. These types of investments typically refer to internal investments in the form of debt securities or equity. Such investments may be in subsidiaries, associates, and joint ventures. Besides this, a business may also invest in real estate and cash. These investments are long-term in nature, that is, held by the business entity for more than one year.
(ii) Intangible Fixed Assets
Intangible assets are the non-physical assets that a business utilizes over a long period of time. These include Patents, Copyright, and Goodwill.
Copyright refers to the exclusive right that the owner of the work has. Such a right stops any other competitor to copy or imitate the original work of the owner. Since its an intangible asset, it is amortized over a period of time.
Likewise, intangible fixed assets may include a patent. The patent refers to the statutory right for an invention granted to the investee for a limited period of time. Such a right is given by the government in exchange for full disclosure of the invention by the patentee. Thus, a Patent excludes others from using the product or invention of the patentee in any form without his consent. Since a patent has a limited useful life as an intangible asset, it is recorded at cost in the balance sheet.
Goodwill is an intangible asset that arises when the purchasing company pays more for the acquired company than the fair value of its net assets. The difference between the purchase price and the fair value of the net assets is recorded as an asset of the acquiring company.
Liabilities are the present obligations of a business. An obligation refers to duty or responsibility of the business entity to act or perform in a certain way. Such obligations may be legally enforceable as a result of a binding contract or statutory requirement. For instance, a contract with trade creditors, lenders, and equity owners against the entity’s assets.
Note that an obligation at present occurs only when an asset is delivered or the business enters into an irrevocable agreement to acquire the asset. A decision to acquire assets in the future does not give rise to a present obligation.
Further, a business can settle these present obligations in different forms, depending upon the terms of the contract entered into. These may include payment of cash, transfer of assets, service provisions, replacement with another obligation, or conversion of an obligation into equity.
Now, the liabilities of a business are further grouped into current liabilities and Other Liabilities.
(a) Current Liabilities
The current liabilities are the liabilities that are expected to be met or satisfied within the normal operating cycle of the business or within one year, whichever is longer. Here, the operating cycle refers to the time period between goods purchased for the manufacturing process and the receipt of cash as a result of selling the final goods.
An e-commerce business may have current liabilities in the form of bills payable, accrued expenses, and deferred revenues.
Accounts payable are the amounts that a business entity owes to its suppliers for goods or services purchased on credit. These amounts occur during the time period between receipt of services or acquisition to the title of goods and payment for such supplies. Credit on accounts payable can be extended typically for 30 days, or 60 days.
Another current liability includes accrued expenses. These are the expenses that are not contractually due. But a business incurs or recognizes such expenses in its income statement. This means that an e-commerce business is yet to pay cash for such expenses. However, it recognizes such expenses in its income statement as it has already received the benefit against such expenses.
Likewise, unearned revenues also form a part of the current liabilities of a business. These revenues are the amounts that a business collects in advance to provide goods or services to its customers. In other words, a business entity receives the payment in advance. But it is yet to deliver the goods or services to its customers.
Such an advance payment means the seller has a liability equal to an amount of revenue generated in advance till the time actual delivery is made.
(b) Other Liabilities
There are other liabilities that do not fall under the current liabilities. Such non-current liabilities are the financial obligations of a business that remain outstanding for more than a year. For instance, long-term debt, deferred tax liabilities, and long-term provision all fall under Other Liabilities.
Long-term debt refers to the loans that a business entity avails of either from a bank, financial institution or indigenous lenders. Such loans are payable after 12 months with interest. For instance, bonds, debentures, and long-term borrowings come under long-term debt.
A business entity takes such a debt to meet its capital needs and to ensure the proper functioning of the business operations.
(c) Deferred Tax Liabilities
Businesses pay tax as per the profits earned in a particular financial year. However, there can be situations when the business pays taxes less than what it was liable to pay.
Thus, a business needs to pay such unpaid taxes of a given year in the next financial year. Such a shortfall in taxes is referred to as the deferred tax liability in the given financial year. This becomes payable in the next financial year along with the next year’s tax.
(d) Long Term Provision
Long Term Provisions refer to the amount kept aside to cover a future liability or decrease in the value of an asset. Such a provision is not a saving. Rather, it is an acknowledgment in advance of a liability that may arise in the future.
3. Owner’s Equity
The owner’s equity is the third head in the balance sheet. It is the amount invested by the investors in the e-commerce business. The owner’s equity is further divided into paid-in capital and retained earnings.
Owner’s Equity = Paid-In Capital + Retained Earnings
Thus, an increase in income or earnings of the business increases the owner’s equity. Whereas, a decrease in earnings of the business decreases the owner’s equity.
Balance Sheet Format
Following is the balance sheet of Amazon as of December 2020.
Consolidated Balance Sheet of Amazon Inc As Of December 31, 2020
(Amount in Million Dollars)
|Current Assets||Current Liabilities|
|Cash and Cash Equivalents||42,122||Accounts Payable||72,539|
|Marketable Securities||42,274||Accrued Liabilities||44,138|
|Total Current Assets||132,733||Total Current Liabilities||126,385|
|Non-Current Assets||Non-Current Liabilities|
|Property, Plant, Equipment Net||113,114||Long Term Lease Liabilities||52,573|
|Operating Leases||37,553||Long Term Debt||31,816|
|Goodwill||15,017||Other Long Term Liabilities||17,017|
|Other Assets||22,778||Commitments & Contingencies||–|
|Treasury Stock at Cost||(1,837)|
|Additional Paid-In Capital||42,865|
|Accumulated Other Comprehensive Income (Loss)||(180)|
|Total Owner’s Equity||93,404|
|Total Assets||321,195||Total Liabilities and Owner’s Equity||321,195|
Recognition Of Assets In Balance Sheet
A business recognizes an asset in the balance sheet only when it is likely that future economic benefits will flow to the entity from such an asset. Besides this, such an asset has a cost or a value that can be measured reliably.
On the other hand, the business may not recognize an asset in the balance sheet when it is unlikely that such an expenditure would render economic benefits beyond the current accounting period. In such a case, a business entity may recognize the expense made on acquiring such an asset in the income statement.
This does not mean that the management’s intent in incurring such expenditure was other than to generate future economic benefits for the entity. Neither does this mean that the entity’s management was misguided with regards to making such an expense?
It simply means that the level of certainty that economic benefits will flow to the entity beyond the current accounting period is insufficient. It is insufficient enough for the business entity to recognize the expenditure as an asset.
Recognition Of Liabilities In Balance Sheet
A business entity may recognize fund outflow as a liability in the balance sheet when it is likely that such outflow of resources will settle the present obligation. In other words, the economic benefits will flow to the business in the form of the current obligation getting settled.
Further, to recognize a resource outflow as a liability, it must be possible for the entity to reliably measure the amount at which the settlement takes place.
On the other hand, there is a possibility that a business entity has certain obligations under contracts that are equally proportionately unperformed. Take, for instance, liabilities arising out of ordered inventory that is not yet received by the entity. If such a situation arises, then the entity will not recognize such a transaction as a liability in the balance sheet.
But if an obligation meets the criteria for liabilities as well as for recognition of such liabilities, then it may qualify for recognition in the balance sheet. In such circumstances, recognition of liabilities necessitates the recognition of related assets or expenses in the financial reports.