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Shopify Dropshipping Accounting: All You Need to Know 

Shopify Dropshipping Accounting

If you are an eCommerce business, you must read this article to understand:

  • What is Shopify Dropshipping?
  • How Does Shopify Dropshipping Work?
  • How To Undertake Shopify Dropshipping Accounting?

The manner in which Shopify Dropshipping works is completely different from how a normal eCommerce store stocking inventory operates. Accordingly, dropshipping accounting is separate from accounting for normal businesses.

One of the major differences between the two models is the manner in which the Purchase Orders are raised. This has a major impact on the books of accounts of an online seller selling goods on his Shopify store.

For instance, the manner in which inventory and sales are recorded into the books of accounts in the case of Shopify dropshipping differs from that of normal business. As a result, the timing of recognizing revenues also varies.

But before moving further, a Shopify Dropshipping seller needs to have a complete understanding of what is Shopify dropshipping? Further, he also needs to understand how dropshipping Shopify works to understand how he can do accounting for Shopify dropshipping?

What is Dropshipping?

Dropshipping is an online selling model in which an eCommerce store can sell goods without storing the inventory. 

In the case of the dropshipping model, an eCommerce store sources products from third-party suppliers. These third-party suppliers are responsible for maintaining product inventory as well as shipping products to customers on behalf of the eCommerce store.

Note that these third-party suppliers could be manufacturers, warehouses, or even family members who make products from their homes. 

In simple words, in the case of the dropshipping model, the goods are shipped directly from the vendor (supplier) to the consumer.

It is a common method of sourcing products for many large and successful businesses. Further, dropshipping has many benefits. However, an online store must know its potential drawbacks and how it can avoid them in order to succeed. 

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One of the best examples of a company selling products online via dropshipping is Amazon.  Amazon’s online stores include merchandise or products that are offered by third-party sellers. It recognizes its net share of revenue of items sold by third-party sellers as service sales. 

Because of its dropshipping model, Amazon is able to turn its inventory quickly and has a cash-generating operating cycle. On average, it has a high inventory velocity which means Amazon generally collects from consumers before its payments to suppliers come due.

Many businesses use dropshipping, partly because it can be easy to set up. Also, the dropshipping businesses earn profits by marking up individual products in exchange for distribution. They are just product curators who need to select the right product mix and market it to customers. 

Benefits of Dropshipping

The following are the benefits that online store owners can get by adopting the dropshipping model.

1. No Need To Maintain Inventory

One of the major characteristics of a dropshipping model is that the online store owner does not need to order and stock inventory himself. As a result, he saves on warehousing costs and can begin selling products online right away. 

In addition to this, the eCommerce seller also does not have to negotiate with warehouses regarding packaging the products in dropshipping. This is because the third-party suppliers do all the storing and packaging of products on behalf of the eCommerce seller.

2. No Need To Fulfill Orders

For an online business, shipping is a challenging part. However, in the case of dropshipping, shipping products to customers is the responsibility of the third-party supplier. It is the third-party supplier, from whom the eCommerce store purchases products, who needs to ship the products to the customer and fulfill the order.

Thus, an online seller can save a lot of time and money in case he adopts the dropshipping model. In addition to this, he can benefit from shipping discounts that his suppliers have negotiated with the shipping carriers.

3. Launch Business Early

Another important benefit of dropshipping is that an online seller can quickly set up a business. As a result, the customers can access the products early and leave product reviews. This is an advantage for the online seller as he gets to learn from his mistakes early and make his business better. 

For instance, the Shopify dropshipping seller can spend a lot of time setting up product collections and the main menu. However, the seller soon discovers that his customers navigate and browse products in a completely different manner. Thus, the eCommerce sellers can redo everything.

Note that the kind of products an online seller sells in his store and the way he organizes them are the key criteria for the success of an eCommerce store. 

However, knowing what’s best for the online store is challenging without customer feedback. If the eCommerce store owner launches business early, then he will be able to grow business with customer feedback.

4. Start at a Low Cost

Starting a Shopify Dropshipping business is one of the best ways to start an online business at a low cost. Launching an online business at a low cost means the online seller can invest the saved money towards building a better business than its competition. 

For instance, the online seller can create content around the products he’s selling online and provide additional value to its customers. 

Also, such a business can reach out to suppliers who supply products to only a few businesses or supply trademarked products that only a few businesses can sell. This helps the eCommerce seller get returning customers. That’s because he is one out of the few sellers from whom the customers can purchase the products.

5. Find Customers Easily

An eCommerce seller selling products via dropshipping model can focus his efforts on marketing the products. Many online store solutions like Shopify provide eCommerce sellers with a host of applications that help them find their customers. 

The business that markets its products is more likely to succeed as compared to the competitors. It can be hard for an online business to find customers, which is why it’s important for it to invest in marketing solutions that platforms like Shopify offer.

Drawbacks of Dropshipping

The following are the drawbacks of adopting the dropshipping model that every online store owner must be aware of.

1. Lack of Control On Product Quality

As mentioned earlier, in the case of dropshipping, the eCommerce seller does not maintain inventory and is not responsible for customer order fulfillment. 

As a result, one of the biggest disadvantages of adopting the dropshipping model is that the online store owner does not have any control over the quality of products, the branding of the packaging, or the speed of order processing. The irony is that these are the major factors that help an online store get positive reviews and repeat customers, which are important for an eCommerce business.

2. Loss Of Savings Due To Shipping

Another major feature of the dropshipping model is that it is the third-party supplier who is responsible for shipping the products to the customer. Note that the third-party supplier is the one who maintains the inventory and from whom the online seller purchases goods.

This means the online seller saves a lot of time and money in case he adopts the dropshipping model. But all those savings go for a toss when such a store needs to handle larger orders. 

Say, for instance, a Shopify dropshipping store receives an order requiring products from different suppliers. In this case, the Shopify store owner will have to pay each supplier the shipping cost for each product. 

However, such a seller can package all the products into one box and pay only one shipping cost if he maintains his own inventory and has the products on hand.

What is Shopify Dropshipping?

Shopify Dropshipping is an eCommerce solution that helps a seller to set up an online store where he can sell third-party products to customers.  The online seller just acts as a curator of products, sourcing them from third-party suppliers. These suppliers maintain product inventory and ship orders to customers on behalf of the Shopify drop shipper. 

Thus, a Shopify dropshipping business owner needs to focus on the store branding, store marketing, and customer management part of his business. Whereas, a third party handles the logistics part for him.

How Does Shopify Dropshipping Work?

Shopify Dropshipping Accounting

The online seller selling products through the Shopify Dropshipping model need not maintain any product inventory. That’s because the products are shipped directly from the third-party suppliers to the Shopify drop shipper’s customers. 

As a result, the drop shipper only pays for what he sells. There is no requirement of investing upfront capital in inventory. Also, there is no pressure on the drop shipper for fulfilling the order. 

Shopify Dropshipping offers a host of applications to help the online seller to fulfill the customer orders. This is because the suppliers of the drop shipper ship the orders directly to the customers. Further, if an eCommerce business has multiple Shopify stores, it can manage all the stores in one place.

In addition to this, the Shopify drop shipper’s account is integrated with marketplaces like Amazon, eBay, and Alibaba. As a result, he can place hundreds of orders within no time. 

Also, the Shopify drop shipper can find cheaper and better suppliers selling the same products at moderate prices. In fact, Shopify dropshipping makes the drop shipper aware of price changes or changes in the stock of products by sending regular notifications.

So, the following is the manner in which Shopify Dropshipping works:

Steps in Shopify Dropshipping

I. Find Relevant Suppliers

The first step to begin Shopify Dropshipping is to find suppliers. Choosing dropshipping suppliers is the most important step towards creating a successful dropshipping business. Note that a dropshipping business would not have any products to ship to its customers without the suppliers.

Also, the dropshipping suppliers must be such who are able to deliver drop shippers high-quality service.  

There are two ways through which a Shopify drop shipper can find suppliers for his dropshipping store. 

The first way is to find suppliers through a supplier database like Dropship Direct, Alibaba, or AliExpress. And the second way to find suppliers is to use an integrated supplier directory like Oberlo in the store’s backend. 

Oberlo is the easiest dropshipping process for Shopify stores. A Shopify drop shipper can source millions of products from the Oberlo marketplace through AliExpress. Then, he can import such products directly to his store with just a click of a button. 

II. Invoice Purchase Orders

The second step is that the Shopify drop shipper must place the orders with the third-party suppliers selected in the first step. Note that the Shopify drop shipper automatically sends the order to the supplier once the customer places an order from the drop shipper’s online store.

The drop shipper raises a purchase order to invoice the goods purchased from the third-party suppliers. Also, the drop-ship purchase orders must have a purchase invoice received against them. This is similar to the way regular purchase orders do. 

It is important to note that in the case of dropshipping, the drop shipper does not maintain inventory. Instead, the third-party suppliers have to maintain the stock on behalf of the drop shipper. Thus, there are no adjustments to the inventory levels of the drop shipper.  

This means the items on drop-ship purchase orders are treated as purchases. Normally, this is not the case. The items in a purchase order are treated as assets as there is an increase in the inventory level of the retailer who buys stock from his suppliers.

This means that a purchase invoice is received against a drop-ship purchase order. As a result, such items are purchases and hence are accounted for in the drop-shipper’s cost of goods sold. What this means is that the cost of goods is linked to the purchase order invoice rather than goods sold linked to the sales order.

III. Invoice Sales Orders

The next step in case of the Shopify dropshipping process is to invoice sales orders. A sales invoice is raised when the consumer places an order with the Shopify drop-shippers online store.

The raising of a sales invoice means a sale is made to the consumer. Thus, the drop-shipper will record such a sale in his books of accounts. In other words, he will record the revenue as well as the tax side of the sale into his books.

As mentioned earlier, the drop shipper does not maintain any inventory. Therefore, in the books of the drop-shipper, there would be no cost of goods sold. Instead, the cost of goods sold is accounted for when the purchase invoice is received.

Note that revenue gets posted to the accounts at the tax date of the sales invoice, and the costs will be posted at the tax date of the purchase invoice.

Be aware of this when you are reporting on the profitability of your drop-shipped sales.

IV. Shipping the Order

Shopify drop shipper automatically sends the order to the supplier once the customer places an order from the drop shipper’s online store. Next, the supplier prepares the order that the customer placed on the Shopify drop shipper’s store. Finally, the supplier ships the order directly to the drop shipper’s customer.

The Shopify drop shipper just needs to double-check that the order details are correct and place the order. The product then ships from the dropshipping supplier to the customer, no matter where they are in the world. 

Note that the Shopify drop shipper is responsible for creating an online store, developing his own brand, choosing the products he wants to sell, and marketing those products. In addition to this, the drop-shipper is also responsible for the shipping costs and establishing prices that result in a good profit margin. 

Shopify Dropshipping Accounting

The following are the items that get impacted in the case of Shopify Dropshipping Accounting.

I. Inventory

Note that in the case of the dropshipping model, you do not receive or maintain any products in inventory. As a result, there is no impact on the inventory levels when a Shopify Purchase Order is raised.

When a customer makes an order on the drop shipper’s online store, the Shopify drop shipper raises a sales invoice against the goods that the customer ordered. Simultaneously, he also raises a Purchase Order against the products that the third-party supplier will supply against the customer order.

This means the Shopify drop shipper will issue a sales invoice to the customer and a Purchase Order to the supplier for each sale made. Once this is done, the supplier will deliver the products directly to the drop shipper’s customer. Thus, the Shopify drop shipper will not have any inventory account involved.

Let’s consider an example to show the accounting treatment for dropshipping inventory. Say, One Republic is an online store that sells consumer goods using the dropshipping model. One of the suppliers supplying consumer goods on behalf of One Republic is Casa.

Say, a customer named Hami, places an order of 10 Soaps at $10 per cake. She pays online upon checking out.

Now, One Republic creates an invoice and issues it to Hami. The following would be the journal entry.

AccountsDebitCredit
Accounts Receivable$100
To Sales$100

Note that Hami makes the payment on placing the order itself. Thus, the following is the journal entry for the receipt of payment. 

AccountsDebitCredit
Bank$100
To Accounts Receivable$100

Now suppose that in place of the drop shipper ‘One Republic’ there is an online store “Topshop” that maintains an inventory of its own. In such a case, it will have to order the products from the supplier ‘Casa’ well in advance so that it has sufficient stock.

In this case, ‘Topshop’ will raise Purchase Orders to store the inventory in his store. It will not raise Purchase Orders to fulfill the orders on a per-order basis as in the case of the dropshipping model.

Say, ‘Topshop’ placed an order for 10 soap cakes at $5 per cake to maintain inventory in its online store. Once  ‘Casa’ fulfills the purchase order and delivers it to ‘Topshop’, the inventory account gets adjusted for ‘Topshop’.

AccountsDebitCredit
Inventory$50
To Accounts Payable$50

Now, ‘Topshop’ can make the payment to ‘Casa’ at any time. That is, either before delivery or after delivery of products. The following will be the journal entry for payment:

AccountsDebitCredit
Accounts Payable$50
To Bank$50

Now suppose that ‘Topshop’ delivers the products to the customer ‘Hami’ who places an order of 10 Soaps at $10 per cake. The following will be the journal entries for inventory on the books of ‘Topshop’.

AccountsDebitCredit
Cost of Goods Sold$100
To Inventory$100

Now let’s consider ‘One Republic’ online store that sells products via dropshipping. The journal entries on the books of ‘One Republic’ will be as follows. 

‘One Republic’ sends a purchase order for 10 soap cakes at $5 per cake to ‘Casa’ when it begins to fulfill orders via dropshipping. The drop shipper places the order with ‘Casa’ to fulfill ‘Hami’s’ order. Furthermore, ‘One Republic’ also mentions ‘Hami’s’ address as the shipping address so that ‘Casa’ directly ships the order to ‘Hami’s’ place.

AccountsDebitCredit
Cost of Goods Sold$50
To Accounts Payable$50

Then, ‘One Republic’ makes the payment to ‘Casa’. Following is the journal entry for the same.

AccountsDebitCredit
Accounts Payable$50
To Bank$50

Note that there is no journal entry for inventory in the books of ‘One Republic’ when it fulfills ‘Hami’s’ order. This is because dropshipping does not involve inventory movement within the business.

II. Cost of Goods Sold

In the case of Shopify dropshipping, the Cost of Goods Sold (COGS) is a key financial metric. It is calculated at the end of every accounting period and allows the drop shipper to determine gross profit. 

The COGS takes into account the cost of the products that the drop shipper sells. It represents the cost that the drop shipper spends on suppliers. 

In the case of the online business model in which the seller owns or maintains the inventory, the following formula is used to calculate the COGS:

COGS = Beginning Inventory Value + Purchases + Direct Expenses – Closing Inventory Value 

In the case of dropshipping, the drop shipper does not hold inventory. This is because the third-party supplier fulfills the order without the drop shipper receiving the items. Thus, the COGS formula for the dropshipping seller is:

COGS = Purchase Price of Product from Supplier + Shipping Costs

III. Taxes

Another important component for drop shipper accounting is tax. A drop shipper may have to charge tax on sales. Then, it may have to report and remit such tax to the local or federal tax authority with which the drop-shipper is registered.

Note that Shopify doesn’t file or remit sales taxes for the drop shipper. The drop shipper needs to register his business with his local or federal tax authority to handle sales tax. 

Shopify calculates the tax automatically for the drop shipper. The ‘Collected Taxes Card’ in Shopify Tax Reports displays the amount that the online store has collected in taxes during the selected date range. The report also displays the number of countries and regions where the drop shipper has been collecting taxes.

The calculations and reports that Shopify provides make things easier when it’s time to file and pay taxes.

Best Accounting Software For Shopify

The eCommerce businesses need to optimize their online store in such a way that they are able to sell more products and deliver excellent customer experiences. 

For instance, an accurate and efficient inventory management solution integrated with the online store can help the seller in managing inventory and avoiding out-of-stock situations.

Likewise, an online seller is in need of easy-to-access updates on the state of his business. An accounting solution integrated with the online store automatically updates accounting data as and when the purchase orders are generated, payments are released, and inventory is moved.

The Shopify accounting software generates up-to-date reports that help a business understand its cash flows and balance sheets. Further, such reports also help the business owners to manage sales and inventory and be prepared to file taxes.

Thus, it’s important for eCommerce sellers to have an accounting solution in place that integrates with their online store and captures data as and when it gets updated.

Shopify’s integration with an accounting solution helps a business generate invoices and automatically process payments.

But the question that many retailers and resellers have is which is the best accounting software for Shopify? In our article, we have revealed our top five preferences for the best accounting software for Shopify.

These include:

  • QuickBooks Online
  • Xero Accounting
  • Sage Shopify Accounting
  • Freshbooks
  • Zoho Books

Need Help With Your eCommerce Accounting / Tax?

We at freecashflow.io are an agency that focuses on helping online business owners like you. Our partners have worked in multi-billion dollar MNCs such as Warner Brothers, EY, and paramount. If you want a trusted partner to help you with your tax/accounting, Freecashflow.io is here to help. 

Head over here to book a call:

Alan Chen Freecashflow.io

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