Cash flow for ecommerce businesses
Ecommerce is a dynamic industry with fast-moving money flows and ever-changing metrics. Because of its unpredictability, your online business's financial health will often fluctuate. That’s why effective cash flow management is critical for your online success.
If you’re looking for one area to focus on that has a significant impact on your ecommerce business’s bottom line, it’s your inflow and outflow of money. Author Denise O’Berry calls cash flow “the lifeblood of your business."
We get it: looking at financial statements can feel confusing and overwhelming. Where’s the money going? Will you have enough cash next month? Can you afford to add inventory or hire a new manager?
Don’t worry – we’re here to help. This guide will dive into the specifics of cash flow for ecommerce, and provide tips to improve the inflow and outflow of your business’s money.
What is cash flow? How does it work?
Cash flow indicates the total amount of cash that comes into and out of your business during a specific period.
You have positive cash flow when more money comes into your business than goes out, allowing you to pay bills and cover business expenses comfortably. Conversely, you have negative cash flow when there’s more money moving out of your business than into it, which means you can’t afford to pay your expenses.
Your ecommerce cash flow can be broken into three categories:
Operating cash flow: This is the net cash generated from your company’s usual business activities. You need a positive number here to maintain your business’s growth.
Investing cash flow: This is the net cash generated from your company’s investments, such as the sale of assets, investments in securities, and purchasing equipment or property. This number will likely be negative if you’re actively investing in your business.
Financing cash flow: This is the net cash generated to finance your ecommerce company, plus its equity, debt, and dividend payments. It describes how money moves between your company and you (the business owner), investors, and lenders.
What is an example of a cash flow?
Cash flow is reported in a cash flow statement, a financial document providing a detailed analysis of what happens to your company’s cash during a given period. It highlights the different areas in which your company spent or received cash. It then reconciles the opening and closing cash balances to show your positive or negative cash balance.
Here’s an example of Amazon’s cash flow statement from its 2020 annual report. The Financial Reporting Council in the UK offers a helpful example of cash flows.
Why is cash flow important for ecommerce merchants?
With no cash, a business will be forced into bankruptcy. It's as simple as that.
A steady cash flow gives you a competitive edge in the market. You can order more inventory, generate more sales, and build long-term relationships with suppliers. You can also sell a variety of inventory, leading to a more diversified business.
On the other hand, if you don’t have enough cash on hand for your ecommerce store’s needs or to replenish inventory, you’ll lose sales and experience disruptions in operations and shortages that will slow – or worse, stunt – your business’s growth.
Having a consistent and healthy cash flow can be the difference between your ecommerce business's survival and collapse. If you manage your cash flow appropriately, you’ll always have enough cash in the cash flow cycle, ensuring you have enough inventory on hand and don't have to rely on lenders.
How do you calculate cash flow?
In a 2021 Forbes article, CEO of tech-empowered startup studio Innovation Department Colin Darretta says:
“It’s absolutely critical that any entrepreneur understand what their business working capital needs are and plan ahead to ensure their ability to finance growth.”
But how do you find out your working capital requirements and avoid the “catastrophic cash crunch it often is for early-stage businesses?“ By calculating your ecommerce business’s cash flow.
You can calculate your cash flow using two methods: the direct method and the indirect method.
1. Direct cash flow method
Under this method, you add up all of the different cash payments and receipts, including cash received from customers, cash paid to suppliers, and salaries.
Suppose your business uses the cash basis accounting method (revenues and expenses are only recognised when cash is received or paid out). In that case, you can easily calculate these figures by using the beginning and ending balances of different assets and liabilities accounts and examining the net decrease or increase.
2. Indirect cash flow method
Under this method, you adjust net income by adding or subtracting differences resulting from noncash transactions.
Your noncash items will show up in the changes to the company‘s assets and liabilities on your balance sheet from one period to the next. Basically, you begin with a net income from the income statement and then adjust to accommodate accruals made during a specific period (e.g., depreciation, accounts receivable, inventory).
You have to identify the net increases and decreases in your company’s asset and liability accounts, which will be added back to or removed from the net income figure, giving an accurate cash inflow and cash outflow.
Admittedly, the indirect cash flow method is slightly more complicated than direct cash flow. But most ecommerce businesses cannot follow the direct cash flow method because they use the accrual accounting method, meaning their revenue is accounted for when it’s earned rather than when it’s received.
This causes a disconnect between net income and actual cash flow because not all transactions in net income on the income statement show actual cash items. Therefore, you'll have to reevaluate certain items when calculating cash flow from operations.
Choosing between direct and indirect cash flow only affects your operating activities. The other two sections – investing activities and financing activities – remain the same.
What is a good cash flow?
Your ecommerce business will have a good cash flow if it consistently brings in more cash than it spends. This positive cash flow means your company can pay its bills and other liabilities.
What are the benefits of a good cash flow?
A good cash flow doesn’t only ensure a steady inflow of money but also enables you to overcome future business hurdles. With good cash flow management, you can:
Ensure you’re never short of cash
Replenish and diversify your inventory
Have greater control over your money
Pay your staff on time
Grow your business
Good cash flow is the key to your business's success – one that lets you address any shortfalls immediately and helps you set your business up for future growth.
Operating cash flow vs. profit
You can refer to your company’s net income and operating cash flows to understand how your ecommerce business is performing and using its cash in operations – but both are very different terms. Since we’ve already discussed operating cash flow, let’s understand what we mean by profit.
Profit is your company's revenue minus all operating expenses. It's the money left after your books are balanced, and all costs are subtracted from your proceeds. You can find your company's profit in the income statement, also known as the profit and loss statement.
Similar to cash flow, you can break your profit down into three categories:
Gross profit: This is revenue minus the cost of goods sold (COGS), including variable costs (e.g. cost of materials, labour required to make the product). But gross profit doesn’t include other fixed costs that you have to pay regardless of output, such as rent and salaries for staff who aren't making the product.
Operating profit: Also known as earnings before interest and tax (EBIT), this refers to the net profit your company earns through its normal business operations. Operating profit doesn’t consider negative cash flows (e.g. tax payments, interest payments on debt) and positive cash flow from areas outside the core business.
Net profit: This is the net income after all expenses (e.g. interest payments, income tax) have been deducted from all revenues.
Clearly, your operating cash flow isn’t the same as your profit. To reiterate:
Operating cash flow is the money that goes in and out of your business during a given period, while your profit is whatever remains from your revenue after deducting costs.
Profit shows you the immediate success of your business, and your cash flow helps you determine your company‘s long-term financial status.
Operating cash flow and profit measure different things. Profits indicate your company’s financial health, but cash flow is the lifeblood that allows it to continue operations.
Interestingly, your online business can be profitable despite poor cash flow. But, for example, if your client delays payment, you may be unable to pay your suppliers or other expenses even if you're profitable.
What is free cash flow?
Free cash flow is the leftover amount of money after paying cash to support company operations and maintain its capital assets. It’s the total amount of money available to repay creditors or pay interest or dividends to your company’s investors.
The formula is:
Free cash flow = net cash from operating activities – capital expenditure
What does a cash flow statement show you?
As mentioned, a cash flow statement for ecommerce is a financial statement summarising your ecommerce business’s cash inflows and outflows during a specific period. It’s a breakdown of your operating, investing, and financial activities during a specific period.
You can use this statement to understand:
How your company’s operations are running
Where the money is coming from
How the money is being spent
Creditors can also use the cash flow statement to determine your company’s liquidity (how much cash it has to fund its operating expenses and pay its debts).
How to improve your operating cash flow
Every ecommerce business is unique, so there’s no cookie-cutter solution to improve operating cash flow. However, there are a few practical tips to run your ecommerce business smoothly.
Negotiate payment terms with suppliers
Set favourable payment terms with suppliers that let you pay for products later, even if it means paying slightly more. We highly recommend this approach if you sell high-margin products.
Reducing the order size when ordering from the suppliers is another alternative – provided your shipping costs are low, and prices don't depend on the scale of order placed (bulk orders at lower prices). This way, you can spread out your orders over time, lowering the possibility of cash flow problems.
Control your expenses
Cutting down unnecessary and non-essential expenses is a proven way to improve your operating ecommerce cash flow.
Examine your list of total expenses to identify unnecessary expenses. For instance, if you’re renting space that you hardly use, you can either move to less expensive premises or stop using an external space completely.
Controlling your business overheads is another great option.
Ask customers to pay earlier
Entice customers to pay earlier by offering them prepayment discounts. For example, you can give a 2% discount to customers that pay money upfront instead of paying the full amount after a month. This will ensure your business always has extra cash in case of emergencies.
Optimise your average order value (AOV)
Another way to enhance your cash flow is to optimise and increase your AOV.
How? A higher AOV means you’ll have to acquire fewer customers to meet your revenue targets, which can help you lower your customer acquisition costs and overall marketing expenses. Plus, as your AOV increases, each acquired customer will bring more cash into your business, ultimately boosting your cash reserves.
Take control of your ecommerce cash flow
The first step to creating a thriving ecommerce business is to manage your cash flow. Once you understand your numbers, you can make sound decisions that take your ecommerce business to the next level. By staying on top of your cash flow statement and taking active measures to improve your cash flow, your business will prosper for years to come.
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