If there’s one lesson that post mortems of failed e-Commerce businesses teaches, it is to start paying attention to your e-commerce cash flow. This is truly one of the e-Commerce metrics that will make or break your success as the owner of an e-Commerce business.
To understand why, take the example of a high-flying e-Commerce store, Dazadi, founded by Jason Boyce and his brother. Dazadi sells recreational sports gear such as ping pong tables, basketball hoops, and fitness equipment. The company experienced a high spurt of growth but nearly went out of business due to inadequate cash flow.
Boyce and his partners made a classic entrepreneur’s mistake by not understanding the importance of e-commerce cash flow. They spent too aggressively on acquiring customers and growing topline revenue. They thought all this money would be made back over time, but ended up with a cash flow deficit after losing $400,000 and narrowly avoiding bankruptcy.
What Is Operating Cash Flow
As an e-Commerce entrepreneur or manager, e-commerce cash flow is the pillar upon which your e-Commerce business stands. Failing to understand what it is and how it works places severe limits on the growth of your store.
The term “cash flow” means the available cash generated by your business over a period of business operations. Typically, you will measure cash flow on a monthly basis to understand the financial health of your business.
A more specific measure of cash flow for evaluating your store’s financial performance is the “operating cash flow” of a business. This is a measure of cash generated by the normal business operations of your business. For e-Commerce stores, the normal, and primary, means of cash flow is selling products in your store.
Use this formula to calculate operating cash flow for your store:
Net Cash From Operations = Cash Receipts From Operations – Cash Outflows For Operations
Let’s unpack the equation to help you understand the different parts of this formula:
- Cash Receipts from Operations – This is cash from your core business activity. For e-Commerce stores, this means cash product sales from your store.
- Cash Outflows for Operations – These are the typical operations outflows for e-Commerce stores: payments to suppliers, all salary payments, interest payments, and income tax payments.
Here is an example to show you how to calculate operating cash flow using this method.
Suppose that your store made $2 million in sales over the course of the year, all cash. Product expenses, all cash, were $1 million. In addition, you paid out $100,000 in salaries, along with $50,000 in interest charges to your bank and $200,000 in income taxes.
The following chart represents how you would calculate your operating cash flow.
Using our formula:
Net Cash From Operations = ($2 million) – ($1 million + $100,000 + $50,000 + $200,000) = $650,000
It means that your core business operations, after paying suppliers as well as taxes and other operating expenses, added $650,000 to the cash position of the business. This will need to be added to your beginning cash balance to arrive at the ending cash balance in your bank account at the end of the period.
Larger businesses often have “financing activities” and “investing activities” that need to be adjusted for in arriving at the ending cash balance.
Difference Between Operating Cash Flow And Profit
A common mistake among e-Commerce entrepreneurs is to confuse cash flow with profit. On one hand, entrepreneurs assume that the cash they have in their bank account is profit which they can take. On the other hand, other entrepreneurs assume that because they have a profit on their financial accounts, that this represents cash available to meet the business’s needs.
In reality, both of these views are dangerous since operating cash flow and profit are not the same. Having cash in the business does not mean you are profitable, and being profitable does not guarantee that you will have all the cash you need to run your business. Both are important factors in growing your e-Commerce store and they require individual attention.
Operating Cash Flow
Operating cash flow differs from net profit in important ways. The former is simply the cash generated from selling products in your e-Commerce store, less cash paid out to cover expenses. It’s possible to have positive cash flow when your company is running a loss supposing you delay payments to suppliers or cover expenses using loans.
In contrast, net profit is the income left over from revenues after you have subtracted all cost of goods (COGS), business expenses, as well as taxes. Notably, having a net profit does not mean you have that net profit available as cash now. Your net profit, for example, might be tied up in new inventory which you just ordered, putting you in a neutral cash position or even a shortage of cash.
Why Does Operating Cash Flow Matter?
A postmortem study on business failures, conducted by CB Insights, shows just why operating cash flow matters for every e-Commerce business. The study analyzed 101 startup failures to uncover why businesses failed. The results were quite shocking since they provided some very unusual explanations for why businesses actually go out of business.
CB Insights’ study showed that almost one in three (29%) failed businesses failed because they ran out of cash. In other words, failure to adequately manage and plan ahead of cash flow challenges is a major killer of businesses.
This cause of startup failure was second only to the primary cause of business failure, which was the market has no need for the product being offered (42% of business failures). Notably, this major reason also adds to a company’s worsening cash flow since the company can’t make sales to generate new cash flow.
The third most common reason for business failure was not having the right team to execute on the business idea, accounting for 23% of failures.
To avoid these failure modes, e-Commerce businesses need to plan well ahead, especially where e-commerce cash flow is concerned. This is one area where prevention is better than cure. Having adequate, consistent, cash flow can mean the difference between survival or death for e-Commerce stores. In addition, if you ever plan to sell your business in the future, many investors will look carefully at your cash flow before deciding to buy or not buy.
Benefits Of Managing Cash Flow
Starting today, you can put in place a program to secure the health of your e-Commerce business with more sustainable e-commerce cash flow. Proper management of cash flow comes with numerous benefits.
As an entrepreneur, good cash flow means more control over your business and your personal financial future. I’m sure we’ve all heard the stories of star athletes who went broke after making a lot of money in their field then retiring. Behind such stories, you often find an athlete who did not understand his or her cash flow and what it implied for their financial future.
Understanding cash flow means you can plan cash flow and foresee problems. This also allows you the flexibility to fix problems before they become crippling. You will have less stress and worries while achieving clarity on what cash you can safely keep or withdraw from your business. Without a firm grasp of the cash flow needs of your business, you might take out too much or not be able to pay yourself an adequate salary because you don’t know.
The biggest benefit, though, is that your e-Commerce business will not run out of cash flow. Instead, you will be able to grow your business and pay your employees on time while avoiding overspending. All this and more emerges out of a healthy e-commerce cash flow position.
How To Improve Your Operating Cash Flow
The correct solution for improving operating cash flow varies from business to business. At ABEL Finance, we are happy to help assess and uncover the best route to stronger e-commerce cash flow for your business.
Not every method is equally suitable. Some steps you should consider include inventory planning based on past sales. This helps you avoid spending too much stocking up inventory, or the opposite problem of having too little inventory thus running out and losing sales.
Payment Terms With Suppliers
You can also arrange payment terms with suppliers so that you pay later, even if that means paying a bit more. This approach works well with higher margin products where the price might be higher. Yet another approach is to reduce the order size when ordering from your suppliers, thus spreading out your payments over time. This can work if shipping costs are low and the price is insensitive to scale of purchases.
Get Customers To Pay Earlier
If you are selling B2B, encourage your customers to pay earlier by giving them prepayment discounts. For example, you can offer a 2% discount if customers pay right away instead of 100% net 30. This way, your business always has extra cash buffers in case of a problem. Unfortunately, this solution won’t apply for Shopify or FBA stores, which are B2C.
More generally, you can also improve your e-commerce cash flow by reducing expenses. Reduce your overhead by finding non-essential expenses that can be safely cut. For example, if you are renting premises you hardly use, you could cut that or move your operations into a smaller, less expensive space.
Optimizing, and increasing, your e-Commerce average order value (AOV) can also enhance your cash flow. This is because, as your AOV increases, each customer you acquire will tend to bring more cash into your business, boosting your cash position. A higher average order value also means that you have to acquire fewer customers to hit your revenue targets. As a result, you will have lower CAC (customer acquisition cost) and less overall marketing expenses.
Planning ahead gives you the opportunity to choose an e-commerce cash flow solution that is cheaper. For example, you might be able to take out a business loan instead of using personal credit cards which are expensive as a financing solution.
Cutting To The Root Of E-Commerce Cash Flow Problems
In sum, e-commerce cash flow problems occur because things are going bad (not enough revenue) OR because things are going well (constant pressure to invest in new inventory) – so managing cash flow is critical. Prevention is better than cure. Once you have cash flow problems, you could run out of cash and lose control over your business. You might be forced to go out of business or sell the business at fire-sale prices. Planning ahead can help you avoid a deadly cash flow crunch, which can occur at the most inconvenient times for your business.
Get Back In Control Of Your Cash Flow Today
If you want a more vibrant e-Commerce business, the first step is to get your cash flow under control right away. While there’s no single silver bullet solution for e-Commerce businesses to help with cash flow, our Virtual CFO team can help. We will help you improve operating cash flow as well as set up cash flow forecasting for the business you have today, then help you grow to where you want to be. Read more about our Finance Insight Program and schedule a call here with Rob, ABEL Finance CEO.