29% of ecomerce businesses fail because they run out of cash, says a recent study. They fail not because their product is not good or because sales are bad. They fail because they don’t manage their cash flow properly to continue working.
Ecommerce is a dynamic business – money moves fast and metrics change daily. Cash flow should be planned and executed carefully to avoid shortages and disruptions of operations. Especially with the coronavirus impact on ecommerce, owners should exercise cash flow discipline to keep the lights on. Data shows it’s possible as determined DTC brands get about 60% of their sales from repeat customers, meaning a stable inflow of cash every month.
Cash flow is the money you have available to cover current expenses to keep the business running. The cash flow formula for ecommerce looks like this:
cash flow = revenue – (rent + payroll + inventory buying + utilities + equipment + marketing + taxes + insurance + interest + fees)
This amount changes weekly if not daily because of the various payments that come in and go out of your business. It is your liquidity at any given moment. A positive cash flow means more money comes in the business than goes out.
A few examples:
Think of it as personal finances: you get your check on payday and pay your bills; but then your car breaks down and you need to pay for repairs. But you’re out of cash right now. It doesn’t mean you won’t be able to pay when you get your next check, but right now you cannot – you’re not broke (because you’re getting money soon) but you don’t have the cash flow to cover the costs as they happen. And that puts brakes to life just like it does to a business.
They are quite different. Cash flow is the rolling balance of money available in the business while profit is the net earnings after all expenses have been paid. Profitability is long-term accounting term, it’s whether you are actually making a profit out of operations.
You can be profitable and still get a negative cash flow sometimes – when you make a big purchase of equipment, for example, or right after you pay payroll. It’s a snapshot of just one moment.
VC-backed businesses are rarely profitable in the beginning but this doesn’t mean their cash flow is bad. They can keep working for years, paying employees, materials, taxes and so on with VC money without making a capital gain. They often fail when they spend too much on things that don’t immediately bring more revenue – like a big flashy office.
On the other hand, a business can be supporting itself, making a good cash flow without turning profit – like NGOs work. This means careful money management keeps it afloat but something in the cost structure is not right to turn a profit yet.
Related: Optimizing profit margins in ecommerce
A healthy cash flow needs careful planning. To avoid cash flow problems, you need to forecast when money is coming in and when to pay your expenses.
Of course, projections can be wrong, but at least you’ll have a more clear idea how to manage your money, what and when you can afford and what your revenue goals should be (hint: enough to cover costs). It also helps you plan when to invest in growing your business and shows investors a stable financial situation.
Here’s what to take into account when forecasting cash flow.
Forecast expected sales without over- or underestimating if possible. Look at monthly averages and seasonality. Factor in special shopping days like BFCM and campaigns you plan. It’s good to plan growth but be realistic: you’ll probably need to invest in marketing to get new customers so plan the cost first and then the revenue over the next months. Use your average AOV to predict new business.
The better customer retention you have, the more regular and easier to predict revenue is. Ecommerce brands with a high repeat purchase rate and lots of returning customers usually manage to keep a positive cash flow because of this stable revenue.
Map out your scheduled payments – there’s usually no way to reschedule when your card gets charged for them. So put down all charges and their due date: payroll, rent, Google AdWords, Facebook Ads, any SaaS you use, your ecommerce platform fees, etc. At least most of them are quite predictable sums so they are easy to project month after month.
Then, estimate utilities, inventory orders, other marketing by looking at old bills and invoices. Work in a buffer for emergencies as well.
Now, your cash flow plan will start taking shape. You’ll see when you need cash if it wasn’t that clear before. And it will become obvious if you have a negative cash flow problem or not.
Once you estimate things, you’ll probably need to improve your cash flow to make it as fail-proof as possible. Here are some tips for cash flow management.
Cash flow works better with high customer lifetime value and regular repeat orders – in other words, high retention businesses have a stable cash flow. So work to retain customers and earn their loyalty.
Here are resources on that:
If you have a relatively predictable number of orders per month, a way to generate more cash with almost the same overhead is to make those orders bigger.
Plus, AOV tells you how many orders you should make extra to cover a shortage of cash. So if you ever need money urgently to pay for the repair of your storage roof, for example, you can run a campaign for your loyal customers to rake up a certain number of additional orders.
Generally, increasing AOV is an easy way to improve cash flow because it’d mean you’ll be in a better cash position without changing your operations in any way, only getting bigger orders.
Quick trick: Offer free gifts (slow-moving items) with orders above a certain value. You’ll get rid of unwanted inventory, get some extra cash from the bigger orders and be able to order new and better inventory with it.
Adjusting your marketing spend can help your cash flow a lot. Maybe you bleed too much money for ads that don’t bring as much as expected. It’s not worth paying hundreds of dollars a month and not getting enough sales through this channel to cover the cost. Monitor the conversions, CLV and loyal customers coming from your different marketing channels (here’s how).
For example, influencer marketing might be bringing better results – and faster, one post and an influx of orders comes in. This will free up cash because you pay the influencer either a revenue share over time (which means smaller lumps of money) or a fixed price that you can negotiate when to pay.
Keep your cash so it makes you more cash – buying inventory, earning interest, etc.- for as long as you can legally. Just don’t go overdue because that usually means penalty fees. You can renegotiate terms to better fit your sales cycle as well. Or pay early if there’s a discount – this saves you money.
For the moments in the month when cash dips, you should keep sales coming in with free marketing campaigns. Such are reactivation email campaigns to loyal and VIP customers. They cost you nothing if you already have an ecommerce email tool and bring in extra cash.
To speed up the money transfer at order, you can offer incentives for people to pay by card if in your country of operation they usually pay on delivery. Making shipping free when they pay by card or adding a small handling fee if they choose cash on delivery will change their behavior.
Another option is buy now, pay later apps because they let customers pay for purchases in installments while you get your money right away.
Obviously, this relates to day-to-day expenses like buying the latest iPhone to answer clients or your own cardboard box printing machine – you don’t need these and buying them might make you delay payroll tomorrow. So think twice.
Also, for small ecommerce businesses it might be a better idea to rent or lease equipment as needed instead of buying it. You won’t shell out a lump of money and your other payments won’t be threatened.
To sum up
Cash flow needs to be carefully managed. Make sure your basic costs are covered before making bigger investments. Stretch out payments to have enough time in between to generate revenue to pay with. Focus on marketing strategies that don’t cost much but bring a good and regular sales volume like retention marketing.
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