If you are an eCommerce business, then you must read this article for the following reasons:
- Understanding what is operating cash flow?
- What are eCommerce cash flow problems?
- How to undertake eCommerce Cash Flow Management?
Cash flows are an important metric for an eCommerce business. One of the top reasons why eCommerce companies go out of business is because of their poor cash management. Many eCommerce businesses focus on growing and becoming profitable, while completely sidelining eCommerce cash flow management.
Though making consistent profits is the first critical step, poor cash flows can make even the profitable businesses go bust. This is because having robust topline revenues won’t help much if they have negative cash flows to run their routine business operations.
Such eCommerce businesses focus heavily on selling for increased revenues. For instance, they may spend aggressively to acquire new customers, stock up an inventory of the highest selling items, etc. This may be done with an expectation that higher growth efforts would bring back cash. However, they eventually end up with a cash flow deficit and in many cases even bankruptcy.
This is where eCommerce businesses need to study and understand Amazon’s eCommerce success. Many factors differentiate Amazon from other eCommerce businesses.
However, one of the key factors is the company’s focus on cash flows since the beginning. As we have already explained in our article on the cash cycle, Amazon gets paid for an item well before it has to pay for the same. This helps the giant to generate positive cash flows for it collects cash from its customers faster and pays its suppliers later.
Thus, Amazon’s focus on achieving increased cashflows has made it possible for the eCommerce giant to innovate over the years and build a sustainable eCommerce business.
Let’s first have a look at the meaning of operating cash flows.
What is Operating Cash Flow?
Operating cash flows are the cash flows that are generated from the core eCommerce business operations over time. In other words, operating cash flows are net cash inflows and cash outflows from your eCommerce business operations.
Since operating cash flows include cash generated from the primary business activities, they must not include any investing or financing transactions. Thus, items such as loans borrowed, equipment purchases, etc must not be included while calculating cash flows from operations in the cash flow statement.
Accordingly, two methods are used to calculate operating cash flows. These are direct and indirect methods of calculating operating cash flows.
Under the Direct Method, operating cash flows are calculated as net cash inflows and outflows.
Thus, Operating Cash Flow Formula (Direct Method) = Cash inflows from business operations – Cash outflows from business operations.
Where cash inflows from operations are the total of cash received from selling items on your eCommerce store.
On the other hand, cash outflows from operations are the total of cash paid in respect of primary business activities. These may include payments made to suppliers, purchasing inventory, making payroll, interest and tax payments, etc.
Under the Indirect Method, you begin from net income/loss and adjust the same for non-cash, non-operating income, and expenses.
Accordingly, Operating Cash Flows (Indirect Method) = Net Income + Non-Cash Expenses – Increase in Working Capital
Where Net Income is nothing but revenue from sales less COGS, operating expenses, selling, general, and administrative expenses, interest, depreciation, taxes, and other expenses. Thus, net income at the bottom of your eCommerce income statement is the item you begin with.
Next, you add back all the non-cash items like depreciation, stock-based compensation, other outstanding income, losses, etc.
Finally, you subtract the increase in working capital. Working capital is nothing but the difference between current assets and current liabilities.
How to Improve Cash Flow for eCommerce Business?
The following are the ways in which you can manage cash flow for an eCommerce business.
1. Ensure Accurate Bookkeeping
Consistent and accurate bookkeeping efforts help in getting a clear picture of your cash cycles, cash flow from operations, and cash in hand. Typically, eCommerce businesses seek the help of eCommerce bookkeeping firms for precise bookkeeping.
These forms offer eCommerce accounting experts who help them in preparing accurate books of accounts. Such experts prepare basic financial statements which give a clear picture of profits as well as cash in hand.
Further, they have experience with selling platforms (like Shopify, Woocommerce, etc), payment processors (like Stripe, PayPal, etc), marketplaces (like Amazon), and accounting software (like Quickbooks, Xero, etc). They ensure that all your accounting data is synchronized with your accounting software so that you have accurate cash flow reports. Further, with the help of online accounting software, these experts can help you:
- manage multri-currency transactions with ease, wiythout worrying about the correctness of exchange rates, fees, and taxes
- automate payments to your regular customers
- send them reminders for timely payments
- integrate multiple merchant processors like PayPal, Stripe, etc so that you know how much fees are you paying towards payment processing
Thus, having a clear view of your cash flows helps you to take appropriate steps for managing cash flows with the help of these experts. For example, you know if:
- your inventory is moving
- you are receiving timely payments from customers
- have an extended payables period
- have controlled operating expenses
- cash flow forecasting
- preparing accounting reports to know real-time financial situation
2. Manage Payables
One of the critical aspects of eCommerce cash flow management is managing your payables. In other words, you must have extended accounts payable so that you cash in hand for an extended period of time.
Getting paid by customers immediately on sale and getting an extended payment period from suppliers is the backbone of the eCommerce business. Getting an extended period for payments to suppliers can be achieved by building strong connections with them.
This puts you in a situation to negotiate better payment terms with your suppliers. Paying suppliers in 60 days instead of 30 is any day better as you have cash available with you for an extended period of time. This helps to fund your working capital needs and helps in accelerating business growth.
Also, with inventory turning around quickly and instant cash receipts on sales, extended accounts payables help in minimizing the cash conversion cycle. That is, the time taken for the amount invested in inventory and other inputs to get converted into sales. A minimum CCC also translates to increased cash flows, which is critical for the success of an eCommerce business.
A lower CCC value reflects efficient inventory management, increased operational efficiency, and efficient decision-making of the management.
3. Manage Inventory
Another critical aspect of efficient eCommerce cash flow management is effective inventory management. Quick turnaround of inventory impacts profitability and is one of the major assets in which large amounts of cash are invested. Inventory not moving can mean cash tied up for a longer period of time.
Thus, you can track inventory through SKUs and see how much inventory gets sold against the new inventory that gets added. If SKUs sold are less than the new inventory added, you need to understand why is inventory not moving?
Thus, inefficient inventory management can mean reduced cash flows for your eCommerce business.
Tracking inventory helps you to identify trends and understand what you may be missing. For instance, you may know if you’re producing for ordering an SKU more than its demand. Likewise, you can identify the highest selling items and order appropriate levels of such items so that you are never out of stock. Also, keeping a check on market trends can help you anticipate the items which can be the highest selling in the future.
Such an understanding helps you to analyze the current and the future demand which helps in ordering the right items, in the right quantity, at the right time.
4. Ensure Profitability
Profit and cash flows are two different items in your financial statements. In other words, profit is not cash flow. A typical mistake that eCommerce businesses make is that they confuse between profit and cash flows.
That’s why there are other eCommerce entrepreneurs who consider cash as profit and think that this is what their eCommerce business earned. Likewise, there are entrepreneurs who treat profit as cash flows and think that they can use it to carry out their routine business operations.
As a result, many eCommerce businesses focus aggressively on increasing revenues for increased profitability. Although, only increasing profitability can leave your eCommerce business cash crunched.
However, eCommerce cash flow management is of no use if your business isn’t profitable.
Therefore, if you want to manage cash flows, you need to ensure that your business is making appropriate profits. Typically, eCommerce businesses fail to make appropriate profits because their :
- revenues are not sufficient to cover their expenses
- product prices do not cover material, labour, and overheads
- operations are inefficient that prevent them from offering competitive prices
- products may have thin profit margins
How Can You Improve Sales Revenue in eCommerce Business?
There are a number of ways in which you can improve sales to increase topline revenue and profitability.
- Use bundling to sell high-margin items with best sellers
- Unloading products that aren’t selling
- Demand a higher prive for items from existing customers
- Offer loyalty programs to premium customers
- Use buy one, get one free strategy for higher margin items
- Cross sell at the checkout by offering related items
- Offer incentives to customers who add items in cart but leave purchase in between
- Improve your average order value by making it easy for customers to locate items of interest on your eCommerce store.
Example: Ecomum’s Faliure to Build a Profitable Business
One of the examples of an eCommerce startup that failed due to profitability issues is Ecomum. Ecomum was an online retail company that sold mom and maternity items. These included toys, food, clothes, and other baby items.
Ecomum was founded in 2007 and achieved a turnover of more than $1 million by 2011. For seeking another round of investment of $12 million, the company had to achieve growth. Ecomum did grow and hit a turnover of $4 million but at the cost of no profitability.
The eCommerce retailer suffered from negative profit margins for three years. And within negative profit margins, the company kept increasing its sales. In such a scenario, increased sales resulted in increased losses.
For every additional order value of $60 shipped, the variable cost was $89, and the eCommerce retailer lost $29. This was the result of ruthless discounting with a daily flat 50% discount on daily deal sites. With such discounting policy and negative profit margins, the company closed in 2013.
5. Undertake Cashflow Forecasting
Taking into account the daily cash inflows and outflows, eCommerce businesses must forecast the future cash flow needs of the firm. Such forecasting can help you to be prepared for your future cash needs. Further, it also helps your business to cope with periods of inconsistent revenues or uncalled expenses.
Apart from this, it also enables you to anticipate the overall financial health of your eCommerce business. Say, your online retail business is profitable today. However, the current cash flow challenges may eat up your profits in the next year. Such scenarios can be anticipated through cash flow forecasting and enable you to take the right actions at the right time.
You may use online accounting software or seek the help of an eCommerce accounting firm to undertake cash flow forecasting.
How to Forecast Cash Flows?
The beginning point is selecting a period, typically one year, for the forecast. Next, sales are forecasted based on the sales for the previous period so as to know how much revenue you can expect every month.
Next, you forecast the inflows that you will receive from both cash and credit sales. Similarly forecast the cash flows including fixed and variable costs on a monthly basis. Lastly, calculate net cash flows by subtracting cash outflows from cash inflows. This will show you the project cash-on-hand balance for every month.
This may give you an understanding of whether you would have enough cash balance in the coming months to cover your expenses. Accordingly, if the project cash balances show a cash deficit for any of the months, you can take appropriate steps in the current period. This is to avoid a cash deficit in a particular month in the future.
6. Consider Short-Term Financing
It is quite possible that you may be implementing the above strategies. However, you still face a cash flow crunch as they may not work for you. For instance, you may not get an extended payables period from your vendors. Or you may be generating cash flows using the above strategies. However, you now are seeking opportunities to grow your eCommerce business.
In such cases, you may need additional working capital. Since you already have the cash flow forecasting done, you know how cash much would be available each month. Based on such forecasting, you can analyze if you would be needing external financing. Or whether self-financing business growth can be a possibility.
Make sure that you are undertaking such an evaluation well in advance. This is because seeking short-term financing is a lengthy process and needs time.
7. Reduce Operating Expenses
Another critical way in which you can improve the cash flows of your eCommerce business is by reducing expenses. The first step in cutting down overheads is to look for expenses that are uncalled for. For instance, you may be stocking too much inventory for a specific item. This may lead to increased operating costs as you may be paying for storage as well as the item which is not selling.
Thus, regular inventory tracking may help you identify such a trend. You may order the appropriate quantity of such items and sell the excess inventory by offering discounts to reduce storage costs.
Similarly, you may enhance the Average Order Value (AOV) to reduce expenses and improve cash flows. Increased AOV would mean getting more cash from existing customers, improving your cash flows. It would also mean fewer marketing costs as you will not have to acquire many customers to achieve your target sales.
Importance of Operating Cash Flows for Your eCommerce Business
As stated earlier, many eCommerce businesses go out of business because of poor cash flow management. Not having enough cash to cover your expenses may eventually eat up your profits and prevent you from growing.
Regular and improved cash flow management means more control over your eCommerce operations. This is because it helps you identify trends and issues, compelling you to take the right actions at the right time. That is, you have a clear view of your cash inflows and outflows which give you key insights to further improvise your eCommerce operations.
For instance, you may know if your inventory is moving quickly, what items are best-sellers, which items can be dropped, etc.
Similarly, you get an understanding of your payment cycle, pricing strategy, operating expenses, and the ROI of your marketing efforts.
Thus, managing cash flows gives you a clear understanding of the liquidity position of your eCommerce business. It helps you to analyze the financial stability of your eCommerce operations.