The virtual bookkeeper’s guide to understanding PayPal

Does the thought of working with PayPal transactions make you want to run and hide? PayPal bookkeeping can be very complicated, even for the most experienced virtual bookkeeper. I definitely struggled to understand the ins and outs of how it works at first. Now I want to share my experience with you. I’m going to show you the essentials of how PayPal works so you can tackle your client’s PayPal transactions with more confidence. Keep reading below, or click on the following video link for my virtual bookkeeper’s guide to understanding PayPal.

Click on the video linked below to watch: The virtual bookkeeper’s guide to understanding PayPal

What exactly is PayPal?

Before we dive in, let’s start by defining what PayPal is and how it is used. You may think of PayPal as a type of bank account. After all, PayPal keeps a balance much like a bank account does, and transactions flow back and forth between PayPal and other bank accounts as well. You can make payments to vendors through PayPal using a linked bank or credit card account, or by using the PayPal balance. You can also use PayPal to collect or receive customer payments. That’s right, PayPal is also a type of payment processor. It processes payments or income from various sales channels like your website, Shopify, or other e-com channels and deposits them in the bank account, net of PayPal fees.

From a bookkeeping point of view, PayPal can also be a pain. With all these different uses, it’s easy to see how business owners and bookkeepers can struggle to understand exactly how it all works. It has confusing reports, and there are a lot of timing differences from the time that you see a transaction processed in PayPal to the time that the amounts are deposited in QuickBooks. On top of that, the PayPal app doesn’t always bring all of the data into QuickBooks, making it hard to reconcile. This is especially frustrating for e-commerce transactions and high volume transactions.

PayPal Workflow Basics

Now that we’ve discussed what PayPal is used for, and touched on a few pain points, let’s go over some of the PayPal workflow basics to help make PayPal bookkeeping as painless as possible. The following workflow assumes that PayPal is connected to QuickBooks Online. In order to successfully work with PayPal transactions in the QuickBooks Online bank feed, you need to work in a particular order to stay organized and avoid duplicating transactions.

Follow these 4 steps:

1. First, you’ll start with a PayPal bank feed. From the bank feeds in QuickBooks Online, you’ll select PayPal Bank (I’m assuming you’ve connected QuickBooks Online to the Connect To PayPal app.)
2. Second, you’re going to categorize expenses. Make sure that you assign the correct account category and then click “Add”.  Be careful that you don’t categorize any withdrawals to the bank account just yet. These are not expenses, they are transfers.
3. Next, you’re going to add or match income transactions and fees deducted. If you have online sales, and you use the Connect To PayPal app in QuickBooks Online, the app will automatically calculate and categorize the fee for you. You have to be careful though because you have to select the correct transaction type, and that depends on the specific income workflow. You may have income that you’re receiving from PayPal that will need to be recorded as a sales receipt or it may be a deposit, it all depends on the type of business.
4. Finally, you will record transfers from the bank / credit card account into PayPal. In the PayPal bank feed, you’ll see the descriptions; “Added Funds from Bank Account”, or “Added Funds from Credit Card.” You’ll select the bank or credit card account as the transfer account and then select “Record Transfer”. For clients with income transactions in PayPal, you will also record any transfers to the bank account from PayPal in this step of the workflow.

Matching vs. Adding (Avoid a big mistake)

After you enter all the transactions from the PayPal bank feed (following the 4-step workflow above), you’ll want to go to the bank and credit card account bank feeds and match the same transactions. This is where most people make a mistake. Without understanding the proper workflow, they go into the bank/credit card account bank feed and add the transaction instead of matching the transaction. When they do that, it duplicates the transactions, and causes a huge mess. Avoid duplicating transactions by making sure that after you add the transfer in the PayPal bank feed, you then go to the bank/credit card account’s bank feed, find that transaction, then click “Match”. You may not see the match at first because the dates are different. There’s a way in QuickBooks Online to edit the date in the bank feed. Make sure it has the same date, and you should be able to match.

The takeaway here is to make sure that you match and you don’t add, because if you add it, you will be duplicating the transaction. Again if the date is not the same or doesn’t agree then you’ll have to change that for it to match.

Preferred PayPal Settings & Setup

Now that we’ve covered workflows, and how to avoid duplicating transactions, let’s dive into preferred PayPal settings and setup. In order to really streamline how PayPal is set up and make your bookkeeping a whole lot easier, there are certain settings that should be active in PayPal. 

First of all, you want to set up the default payment to either be from a credit card or bank balance and not the PayPal balance. If you have any expenses that are paid directly from the PayPal balance, it makes the bookkeeping so much more complicated. You’ll also want to set up the auto transfer to transfer the balance in PayPal to the bank account every day. (This would apply to clients that are receiving income into PayPal). It makes it a lot easier for them to get their money sent to their bank account every day directly from PayPal without having to remember to transfer funds. For a screen by screen example of how to change these settings, make sure to check out my video tutorial linked here.

Next, it’s very important to use separate PayPal accounts for paying expenses and for receiving income. This is actually a requirement that I have for the clients that I work with, and I have a lot of e-commerce clients who actively use PayPal in their business. So, if they’re using PayPal to receive income from their various sales channels and they also want to pay expenses through PayPal, then I require that they set up separate PayPal accounts, one for expenses and one for income, which makes the bookkeeping a lot simpler!

Lastly, I also ask clients to set up separate PayPal accounts for each sales channel. Now, this is a bit more advanced, but if they’re selling through different sales channels (maybe their website and then Shopify) and using one PayPal account, you won’t know which sales go with which sales channel – this can make things very complicated. So I simply have them set up a separate PayPal account for each sales channel.

PayPal Reports

Finally, in terms of reports, I really like the Activity download report because it will download a .CSV file that I can open up in Excel and do some calculations. To use this report, just select Activity download, select the month that you’re looking to work with, click Create Report, wait for the report to process, and click Download. You’ll get a .CSV file and, as I said, you can open it up in Excel and see all the details of every sale and every transaction. In this report you’ll see sales, expenses, and transfers and you’ll see the gross amount, any fees, and the net amount.

Closing

I hope that this virtual bookkeeper’s guide to understanding PayPal gave you helpful insights into how PayPal works. I know that it’s lot of information to take in (and this is just an overview), but when you use my preferred PayPal settings and consistently follow the proper workflow, you’ll begin to see how just how PayPal works, and it will get easier. Soon you’ll have the confidence to tackle even the biggest PayPal messes in your next QuickBooks Online cleanup project, and keep PayPal messes from happening in your client’s monthly bookkeeping work.

For more QuickBooks Online cleanup topics, follow this link to the QuickBooks Online Clean Up Playlist on my 5 Minute Bookkeeping YouTube channel. While visiting my YouTube channel, make sure to subscribe, leave me comments, and share with other’s who you think would find this content useful as well. Finally, if you have any specific questions about PayPal or e-commerce bookkeeping, let me know. I’d love to create more content that answers those questions for you.

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