Measuring Costs and Calculating Profits
Understanding the profitability of your seller account is crucial for making informed decisions about inventory management, procurement, and pricing. It’s important to be able to answer questions such as which products and brands are profitable, which ones should be restocked, and which products have the highest opportunity cost if they run out of stock. In this chapter, we will explore the importance of assessing profitability and provide you with the necessary tools to make smart business decisions.
Unfortunately, there are common misconceptions among sellers when it comes to profitability. Some sellers mistakenly believe that as their topline sales increase, their bottom-line profits will automatically grow. Others assume that as long as they sell products at a fixed markup over their purchase price, they are making money. There is also a tendency to assume that high-volume products generate significant profit. Additionally, many sellers use competitors’ prices as a starting point for their own pricing strategies. Lastly, some sellers evaluate their total profits only at year-end when preparing for taxes. We aim to dispel these myths and equip you with the knowledge to understand the profitability of different aspects of your business.
By gaining insight into your profitability, you can make intelligent decisions regarding inventory replenishment, identifying lucrative suppliers, brands, and products, negotiating better acquisition costs and prices, pricing your products appropriately, and determining whether to carry specific products for reasons beyond profit margin. Regardless of the type of Amazon seller you are, your ultimate goal is to generate profits for your business. Therefore, we will provide guidance and tools to help you track both obvious and hidden costs, enabling you to make informed decisions about the products in your Amazon catalog.
It’s important to keep in mind that while your objective is to improve bottom-line profits, Amazon’s objective is to encourage you to increase top-line sales. Amazon’s focus is not necessarily on whether you are making profits on your sales; it wants you to keep selling more products, even if it means operating at a loss. Throughout my experience at Amazon, there was never a program dedicated to helping sellers improve profitability and long-term survival. If a seller experienced significant losses, Amazon’s approach was to quickly replace that selection from as many sellers as possible, regardless of their profitability. Most of the reports in Seller Central primarily focus on topline sales, but we will show you how to extract information about other costs that may be less transparent in these reports. By taking a data-driven approach, you can make better decisions that prioritize putting profits into your own pocket.
In the following sections, we will delve into specific strategies and techniques for measuring costs, identifying profit drivers, and improving your overall profitability as an Amazon seller. By leveraging these insights, you will be able to navigate the complex landscape of e-commerce and build a business that consistently generates profits.
To ensure clarity and a shared understanding, let’s define a few key terms we’ll be using throughout this discussion:
Seller Profits: In the context of accounting, profit (or net income) refers to the difference between the purchase price of your products and the costs associated with bringing them to market. While sellers are typically aware of the purchase price, there are various hidden or less obvious costs that need to be considered in the overall process of bringing products to market. These costs include overhead expenses, Amazon fees that may not be immediately apparent, and costs related to returns. It’s important to recognize these less apparent costs as they can accumulate and potentially lead to sellers working hard to generate Amazon referral fee revenue, but without actually making profits or even experiencing losses.
Opportunity Cost: As a seller, you have limited time and financial resources. Considering this, it’s crucial to evaluate how you could be utilizing these resources if you weren’t dedicating them to your current product offerings. The concept of opportunity cost comes into play when considering the choices you make regarding the products you carry in your inventory, the quantities you stock, and the timing of your inventory. Are there missed opportunities for higher profits due to suboptimal choices? This question lies at the heart of our discussion on profitability.
Overhead Costs: Running a business incurs various expenses beyond the direct costs of purchasing and selling products. Overhead costs encompass expenses such as warehouse maintenance, employee salaries, heating, insurance, taxes, licensing, product development, business travel, loan interest, software subscriptions, and more. It’s essential to account for all these costs when evaluating the overall expenses incurred by your Amazon seller business.
Acquisition Cost: Acquisition cost typically refers to the purchase price of the products you buy. However, it’s important to recognize that there may be additional costs directly related to the acquisition of specific products. These costs could include inbound shipping fees from your supplier to your facility, bank wiring fees, customs fees, and any other expenses directly associated with acquiring specific products. Our goal is to ensure that you explicitly consider as many costs as possible, enabling you to understand their impact on your overall Amazon seller business, both collectively and for each individual product.
Repricing Software/Repricers: Repricing software or repricers are external tools provided by various software providers. They offer automation capabilities for adjusting your prices on Amazon. Typically, these software tools allow you to set a floor price (the minimum price you’re willing to accept) and establish rules for when and how your prices should be changed. While these tools can be helpful in automating the repricing process, it’s crucial to note that many sellers have adopted these tools without fully measuring their total costs. As a result, sellers may set floor prices that actually lead to losses without realizing it. Repricing software should only be used when sellers have a comprehensive understanding of their total costs to ensure informed decision-making.
In the following sections, we will delve into specific strategies and approaches to help you accurately measure costs, identify profit drivers, and optimize the overall profitability of your Amazon seller business. By gaining a deep understanding of these concepts, you will be able to make informed decisions about the products you carry and the strategies you implement to maximize your bottom-line profits.
Data-Driven Purchasing: Profitability/Cost Measurement
When it comes to managing costs effectively in your Amazon seller business, we follow three key principles
Be Inclusive on Costs: To accurately assess profitability, it’s crucial to identify and allocate as many costs as possible. Even if you are uncertain about the exact placement of a cost, the primary goal is to ensure that all costs are brought to light and accounted for. Inclusion is essential, as it enables a comprehensive understanding of the overall cost structure of your business.
The SKU is the First Level of Analysis: The SKU (Stock Keeping Unit) serves as the foundational level of analysis. You need to establish a model that allows for the allocation of costs down to the SKU level. While certain costs may need to be averaged and applied across all SKUs, other costs can be specifically assigned to individual SKUs. The key is to examine your business at a granular level, focusing on SKUs rather than taking a broad, overall perspective. By understanding profitability at the SKU and brand levels, you gain valuable insights into which SKUs are the most and least profitable for your business. This information enables you to take targeted actions to optimize inventory management, procurement strategies, and pricing practices.
Conduct Regular, Repeated Measurement: Measuring profitability should be an ongoing process throughout the year, rather than a one-time assessment at year-end. It is essential to track profitability regularly to identify any areas where profits are being eroded or to recognize highly profitable products. By conducting frequent measurements, you can promptly address issues, take corrective actions, and capitalize on opportunities. While it may not be practical to update profitability measurements on a daily or weekly basis, we strongly recommend updating your data at least monthly. This regular measurement allows you to identify changing trends, potential challenges, or emerging areas of concern within your business. Timely awareness empowers you to make informed decisions and implement necessary adjustments to maximize profitability.
To gain a comprehensive understanding of your actual profit margins, it is crucial to track the various costs involved in your business operations. These costs can be categorized into two main types: transactional costs and overhead costs.
Transactional Costs: Transactional costs encompass expenses directly associated with the transactions you make as an Amazon seller. These costs include:
Cost of Goods Sold: The amount you pay to purchase products from your suppliers.
Shipping Costs: This includes the shipping expenses incurred when receiving products from your supplier, shipping products from your location to Amazon’s FBA (Fulfillment by Amazon) centers, FBA shipping costs for sending products to customers, and shipping costs to deliver products directly to customers.
Referral Fee: The fee paid to Amazon as a percentage of the item’s sale price.
Per Item Fee: A fee charged by Amazon for each unit sold.
Customs and Wiring Fees: Fees associated with customs clearance and bank wiring when buying products from overseas suppliers.
Product Return Costs and Fees: Expenses incurred for product returns, including shipping costs and any additional fees.
Overhead Costs: Overhead costs refer to the ongoing expenses necessary for running your Amazon seller business. These costs include:
Monthly Amazon Fee: The recurring fee charged by Amazon for selling on their platform.
Warehouse Costs: Expenses related to maintaining a warehouse, such as insurance, rent, labor, utilities, repairs, office supplies, property tax, and storage fees.
Cost for Product Samples: The cost associated with acquiring product samples for testing or evaluation purposes.
Travel Costs and Other Business Expenses: Expenses incurred for business-related travel, membership dues, certification fees, legal fees, licensing, and healthcare expenses.
FBA Storage Fees: Fees charged by Amazon for storing your products in their fulfillment centers, both for short-term and long-term storage.
FBA Inventory Placement Service Fee: A fee charged by Amazon for their inventory placement service.
Shortage: Costs associated with any inventory shortage or shrinkage.
Computing and Web Expenses: Expenses related to computing resources, website hosting, and other online services.
Feedback Software: Costs associated with feedback management tools or software.
Repricing Software: Expenses related to repricing tools used to dynamically adjust product prices.
Channel Management/Inventory Management Software: Costs associated with software used for managing inventory and sales channels.
Additional Marketplace Software: Expenses related to other software tools used for managing sales and operations on various marketplaces.
Any other miscellaneous business expenses: This includes any additional costs specific to your business operations.
Inventory Financing Costs: Expenses related to financing inventory, such as interest charges.
Amazon State Sales Service Fees: Fees charged by Amazon for collecting and remitting state sales taxes on your behalf.
Uncollected State Sales Taxes: Any uncollected sales taxes for which you are responsible.
The first two costs, Cost of Goods Sold and Shipping Costs, are typically well-known to sellers as they directly relate to the purchase and transportation of products from suppliers. Costs three through eight can be found in the “All Statements” report within the “Reports” section of your Amazon Seller Central account.
If you source products from overseas suppliers, the customs and bank wiring fees can usually be accessed through records kept by customs clearing organizations and banks, as they share this information with sellers.
Other Costs and Fees
Now let’s dive into some of the more complex aspects of cost tracking. While Amazon does provide information on product return costs and fees, many sellers struggle to understand and align them with specific SKUs.
Return Rates: It’s important to recognize that not all products have the same likelihood of being returned by customers. Additionally, products fulfilled by Amazon’s FBA service generally have a higher return rate compared to products fulfilled by sellers themselves. However, it’s essential to consider the high customer conversion rate associated with FBA products when assessing the overall impact on your business. Understanding SKU-level return rates within Seller Central can be challenging. While you can view returned orders, determining which SKUs within those orders were returned can require some intricate analysis. This is particularly true for orders that involve multiple SKUs or units. Tracking returns becomes easier if customers return products directly to you, as you can keep a record of the returned items. However, when products are returned through FBA, the process becomes more complex. Some returned products are immediately returned to your active FBA inventory as re-sellable after being graded by Amazon, while others are placed in unfulfillable inventory. In the latter case, you’ll need to decide whether to pull the items back to your location or request that Amazon dispose of them. We will explore this topic further in the Order Fulfillment / Returns chapter.
Shipping Costs: When FBA orders are returned by customers, the handling of return shipping costs can vary. In some cases, the customer may be responsible for return shipping fees, while in others, the seller bears the cost. Additionally, each seller may have different policies regarding who covers shipping costs for items returned in orders fulfilled directly by the seller.
What to Do With Returned Product: Once a product is returned by a customer, you need to decide what to do with it. Some products can be cleaned up and prepared for resale, while others may need to be disposed of.
Resale Rate: The likelihood of reselling returned items differs depending on the SKU. Some returned products can be easily resold as new items if they are still in their original packaging and undamaged. However, there are cases where products can only be sold as used because the original packaging is missing or irreparable, or the item itself has been scuffed, damaged, or altered by the customer.
To facilitate the resale of returned products, it is advisable to save any extra parts, packaging, warranty slips, and instruction manuals. These items may be necessary to restore a returned item to a new condition before reselling it.Tracking and managing the costs associated with returns can significantly impact your overall profitability as an Amazon seller. By effectively managing these processes and understanding the potential for resale, you can minimize losses and optimize the financial performance of your business.
Monthly Amazon fee: This fee is charged by Amazon on a monthly basis for using their platform to sell your products. It is a recurring cost that sellers need to factor into their expenses.
Warehouse costs: Warehouse costs encompass various expenses related to the operation and maintenance of your physical storage facility. These costs may include insurance, rent, labor, utilities, repairs, office expenses, property tax, and storage fees. They are essential for running your business and should be considered in your overall cost analysis.
Cost for product samples: When sourcing new products or considering additions to your inventory, you may need to purchase samples for testing and evaluation purposes. The cost of these samples should be included in your cost calculations.
Travel costs, membership dues, certification fees, legal fees, licensing, health care expenses: These costs cover a range of business-related expenses. They can include travel expenses for attending conferences or meetings, membership fees for professional organizations, certification fees for specialized training, legal fees for legal counsel, licensing fees for specific products or services, and health care expenses for yourself or your employees.
FBA storage fees (short-term and long-term): If you utilize Amazon’s FBA service, you will incur storage fees for keeping your inventory in their fulfillment centers. These fees can vary depending on the duration of storage, with separate rates for short-term and long-term storage. It’s important to include these fees in your cost calculations to get an accurate view of your expenses.
FBA Inventory Placement Service Fee: When using FBA, you have the option to choose between distributed inventory placement or consolidated inventory placement in Amazon’s fulfillment centers. If you opt for consolidated placement, a fee known as the FBA Inventory Placement Service Fee is applied. This fee should be considered in your cost analysis.
Shortage: Shortage costs refer to the losses incurred due to stockouts or inventory shortages. When you run out of stock, you may miss out on potential sales or incur additional expenses to replenish inventory quickly. These costs should be accounted for in your overall profitability analysis.
Computing and web expenses: These costs include expenses related to maintaining your computing infrastructure, website, or online presence. They can include costs for hardware, software, web hosting, domain registration, and other computing-related services.
Feedback Software: Feedback software tools can help you manage and monitor customer feedback on your Amazon listings. The cost of using such software should be factored into your expenses, as it contributes to your overall cost structure.
Re-pricing Software, Channel Management/Inventory Management Software, Additional Marketplace Software
If you utilize software for repricing your products, managing inventory across different channels, or other marketplace-related tasks, the associated costs should be included in your cost calculations. These software tools can enhance your operations but come with their own expenses.
Additionally, it is essential to consider any other miscellaneous business expenses that are relevant to your operations. These expenses can vary depending on the specific needs of your business and should be accounted for to obtain an accurate picture of your costs.
When allocating overhead costs to your orders, it’s crucial to determine the appropriate portion to be applied. This requires considering factors such as insurance, rent, labor, utilities, repairs, office expenses, property tax, and storage costs. Depending on your business model and the use of your warehouse space, adjustments may need to be made to allocate the overhead costs to your Amazon business accurately.
As your business grows, you may need to review and adjust your overhead cost allocation. As you streamline your operations and potentially reduce your total overhead per order, periodic updates to your allocation rules or guidelines can help you gauge the impact of overhead costs on your Amazon seller business. While it’s not necessary to calculate and recalculate overhead cost allocations frequently, having a periodically updated rule of thumb can provide valuable insights into your business’s cost structure.
Amazon State Tax Service Fee: Amazon charges a fee of 2.9% on the sales tax revenue it collects on behalf of sellers. This means that sellers will receive 2.9% less than the actual sales tax revenue collected by Amazon, and they will need to cover this difference themselves. The “Sales Tax Service Fee” can be found in the “Reports,” “Payments,” and “All Statements” files under the “Item-Related-Type-Fee” column.
Uncollected State Sales Taxes: If, for any reason, you fail to collect the sales tax that you are legally obligated to collect on orders you have sold, this becomes a liability that should be considered as an expense and allocated back to your orders. By choosing to start collecting sales tax, you can eliminate almost all of the out-of-pocket expense associated with uncollected taxes (except for the Amazon Sales Tax Service Fee).
While it is possible that you may not be collecting sales tax on some Amazon SKUs while collecting on others, it may be more straightforward to allocate this liability across all orders. However, if you have found a more appropriate way to allocate it to specific SKUs, feel free to implement that approach. It is important to keep in mind that your Amazon competitors can range from small, home-based businesses with minimal overhead to large multinational companies with significant overhead costs allocated to their online sales division.
By diligently measuring and tracking your overhead costs, you can proactively identify strategies to minimize allocated overhead costs and ensure that your total costs align with the prices at which you sell your online products. As a rule of thumb, a home-based seller without a warehouse may have an overhead allocation cost of under $1.50 per unit sold, while a company with a warehouse and staff may have overall costs ranging from $1.00 to $3.00 per unit sold. If your profit margin calculations, based solely on direct product costs, are less than $3, it is possible that you are losing money once overhead allocation costs are considered. This raises the question of why you wouldn’t focus instead on optimizing profitability by addressing these cost factors.
Tracking and controlling your overhead costs can play a vital role in your business’s success. By effectively managing these expenses, you can enhance your profit margins, maintain competitive pricing, and make informed decisions to optimize your Amazon seller business.
Lowering Your Overall Overhead Costs & Finding Higher Price-Point Products To Sell
When it comes to tracking your overhead costs, two important questions need to be addressed
- What proportion of each overhead expense should be allocated to your Amazon.com business?
- What overhead cost allocation per unit sold should be made to each of your Amazon.com orders?
It is crucial to fully consider your overhead costs when analyzing the profitability of your products on Amazon. Many sellers fail to factor in these costs, leading to products that may appear profitable on the surface but turn out to be unprofitable once overhead cost allocation is taken into account.
Fortunately, there are software options available that can help you determine the actual profitability of your products, such as Sellerscale, HelloProfit, and Fetcher. By incorporating your cost data into a profitability model, you can assess the true margin across all the units you have sold over the past 6-12 months.
Applying margin calculations per SKU to each sale will provide you with two valuable columns of data
- % of Revenue generated per SKU
- % of Margin generated per SKU
With this comprehensive view of your overall costs, you can uncover various scenarios
- Certain items may be more profitable to discontinue selling, leading to increased overall profit.
- Ensuring consistent stock availability for a small portion of products could result in greater overall profit.
- Shifting focus from low-priced products to higher-priced ones, even if the profit margin on the higher-priced products is lower, may yield higher overall profit.
- While some products generate positive profit, it’s worth considering if there are other products with a higher positive profit per sale that could replace the inventory investment in low-margin products.
By taking these factors into account and actively working to lower your overall overhead costs, you can optimize your profit margins, make informed decisions about product selection and stock management, and maximize the profitability of your Amazon seller business. Utilizing the insights gained from a comprehensive cost analysis, you can strategically align your efforts and resources to focus on products that generate the greatest returns.
In the world of Amazon selling, there is an increasing number of “repricing” tools available that automate the adjustment of pricing for your Amazon listings. These tools are designed to lower your current price, if necessary, in order to keep you competitive for winning the Buy Box. They continue to adjust the price until it reaches a floor that you have set.
Some popular repricing tools include
While these tools are gaining popularity among Amazon sellers, it is important to note that without a clear understanding of your overall costs, you run the risk of setting a floor price that is below your breakeven point. This can result in pricing your products at a loss without your knowledge. Unfortunately, many sellers overlook less-visible costs such as overhead costs and return-related costs when offering products for sale on Amazon.
To set an effective floor price in a repricing tool, it is crucial to consider different layers of understanding.
Let’s illustrate this with an example:
Imagine you are wholesaling a SKU for $50, including shipping from your supplier, and you plan to sell it on Amazon for $80, utilizing FBA for fulfillment.
Assuming an Amazon referral fee (or commission rate) of 15%, let’s calculate the profit:
$80 – 15% * $80 (referral fee of $12) – ~$3 (FBA fee) – $50 (acquisition cost) = $15 per unit sold.
If we include the overhead cost allocation of $3 per unit, the profit decreases to $12.
Now let’s consider a 25% return rate for this item, with the ability to resell returned items at 75% of the original new condition price.
This recovery rate translates to a reduction of $20 on the selling price, averaging out to an additional $5 cost per item when accounting for the 25% return rate.
Keep in mind that Amazon retains 20% of the original referral fee on any returned item. Therefore, the $2.40 of Amazon return referral fee per returned item amounts to $0.60 per item, regardless of whether it was returned or not.
If return shipping from the customer to you costs $4 per return, we need to account for an average of $1.00 for return shipping across all units, considering the 25% return rate. And we still haven’t factored in any costs associated with inbound shipping to FBA or FBA storage.
As a result, the initial apparent profit of $12 per unit sold has already dropped by approximately $6.60 ($1 + $0.60 + $5), a significant portion of the initial profit figure.
When utilizing a repricing tool, it is crucial to have a clear understanding of all your costs, even if you need to estimate and allocate those costs using rules of thumb. While automating tasks like repricing is appealing, it is essential to incorporate all costs into your calculation of the lowest price you are willing to sell each SKU.
Moreover, understanding and periodically updating your costs, starting with your overhead allocation costs (often the most overlooked cost), is vital. By staying informed about your costs, you can ensure that you price each of your products in a profitable manner, maximizing your overall profitability in the Amazon marketplace.
Processes to Implement
In order to calculate your profitability accurately, it is crucial to keep track of both revenue and cost numbers. Here are some processes you can implement to streamline your data organization
Product Costs: It is recommended to organize and document your product acquisition data, whether through purchase orders or packing slips from your suppliers. While some of this information may already be entered into your accounting software, ensure that you can quickly access your product cost data when needed, especially for calculating the acquisition cost per SKU in your Amazon catalog.
Supplier Shipping Costs: If your suppliers charge separate shipping costs, it’s important to keep track of the total shipping costs per brand per supplier. Documenting this information when you place an order and receive shipping or billing confirmation from your supplier is the easiest approach. Consider maintaining a simple spreadsheet that includes each order, the number of SKUs by brand, and the total shipping cost for that order. This way, you can accumulate the necessary data to calculate the shipping cost per unit for each brand you carry.
While there may be some averaging of costs involved, such as applying the same shipping cost per unit for the same brand despite variations in weight or dimensions, it is not necessary to de-average shipping costs to the minutest detail. Typically, there are other more significant cost drivers to address. Nevertheless, it is essential to include shipping costs in your profitability model, so regularly update your spreadsheet to avoid the hassle of sorting through a pile of invoices or shipping forms to determine shipping costs per unit per brand.
Overhead Costs: Your overhead costs should be visible in your checkbook, as you likely make monthly payments for most of them. You can pull data from your accounting software or your chosen record-keeping process to calculate the total overhead cost that needs to be allocated to your Amazon orders. These costs include expenses such as rent, utilities, insurance, labor, and office supplies. By accurately tracking your overhead costs, you can factor them into your profitability calculations and gain a better understanding of the true costs associated with your Amazon business.
At Basilio Inc., we offer a comprehensive accounting service designed to support our clients in maintaining accurate financial records for their Amazon seller businesses. Our dedicated accounting team specializes in gathering invoices from our clients’ manufacturers or authorized supply chains, ensuring that all relevant data is compiled and organized efficiently.
With our expertise in accounting for e-commerce businesses, we understand the unique challenges faced by Amazon sellers, especially when it comes to managing complex financial transactions and reconciling various invoices. By leveraging our accounting team’s skills and knowledge, we can provide our clients with a streamlined process for maintaining accurate accounting records.
One key aspect of our service is ensuring that our clients’ accounting is indeed accurate. We meticulously review and verify the invoices received from manufacturers or authorized supply chains, cross-referencing them with other financial documents to ensure consistency and accuracy. This attention to detail helps our clients maintain reliable financial records, which are crucial for making informed business decisions and meeting tax obligations.
In addition to ensuring accurate accounting, we also specialize in assisting our clients with FBA (Fulfillment by Amazon) reimbursements scenarios. FBA reimbursements can be a complex process, involving issues such as lost or damaged inventory, overcharged fees, or discrepancies in inventory reconciliation. Our accounting team is well-versed in navigating the intricacies of FBA reimbursements and can provide valuable support to our clients in resolving such issues.
By utilizing our accounting team at Basilio Inc., our clients can focus on growing their Amazon businesses while having peace of mind knowing that their financial records are in capable hands. We strive to provide a seamless and reliable accounting service that helps our clients maintain accurate financial data and maximize their profitability. Whether it’s compiling invoices, reconciling financial records, or assisting with FBA reimbursements, our experienced accounting team is dedicated to delivering top-notch service and support to our clients.