Access to much-needed working capital has been a recurring challenge for e-commerce businesses. Lenders view these alternative business models as riskier than their traditional brick-and-mortar counterparts.
Indeed, e-commerce stores are subject to unique risks like service disruption involving their websites, security breaches, and changes in Google’s algorithm in addition to the usual risks businesses face. Fortunately, alternative lending platforms on the Internet have stepped up to fill this gap in financing. Even so, e-commerce proprietors still need to learn to manage their working capital to maximize their cash flows and ensure their shops’ longevity.
Inventory turnover is the rate at which a business converts its stocks into cash. Every e-commerce business should liquidate its inventory as much as possible. Otherwise, inventory that stays too long on the shelves could tie up money that could otherwise be circulated within the business or used for an emergency.
There are various methods that could help in shortening inventory turnover. One of these is increasing the advertising budget. Aggressive marketing, if planned and executed accordingly, can improve sales and hasten the disposal of inventory.
Another method is to use smart inventory management systems to monitor turnover rates of individual items and plan future purchases based on that information. This is possible through Sales analytics available in most e-commerce sites like Shopify.
One advantage that e-commerce businesses have over their traditional counterparts is their easy access to insights and historical data. As mentioned above, sales analytics can be quickly pulled up from the shop’s e-commerce website for study and deliberation. Other data can also be obtained including historical data on inventory movement.
Entrepreneurs should make it a habit to look for trends in inventory movements at any given time. Careful study of graphs and tables will yield patterns that mark the business’ high and low seasons. Identifying these trends helps entrepreneurs decide how much inventory to buy at any time of the year. This also assists the business in preparing for the expected slow or fast inventory movements.
Sound inventory decisions informed by historical data on sales ensure that the business is not spending too much money on inventory that it might find difficult to dispose of quickly. Storing inventory too far in advance also dilutes the value of that stock. The shop will be forced to sell them off at discounted prices if they sit on the shelf for an extended period.
More often than not, an e-commerce business runs into cash flow problems because of vendor terms. For instance, some businesses may enter into 30-day invoice terms with their suppliers but, in reality, they take more than 30 days to dispose of their inventory.
Cash and credit card payments reflect almost instantaneously on an e-commerce shop’s bank account, but 30-day invoice terms in this context are cutting it too close. Customers might also request refunds, which will take away from revenues and affect available working capital. These businesses are better off negotiating at least 45-day terms with their suppliers.
Each business’ circumstances differ from one another. What’s important for the entrepreneur to consider are the number of days it takes to sell stocks and the costs associated with holding inventory. They should then gauge if the business needs a bit more leeway with payment terms with these concerns in mind.
E-commerce paved the way for several unique business models, including dropshipping and print-on-demand. Sites like Etsy and Shopify allow vendors to hook up with on-demand services to sell custom-printed merchandise like t-shirts, cups, books, and picture frames, among others.
Fulfillment is nearly fully automated – the vendor receives the order from the e-commerce website, collects payment, and then ships the finished product over to the customer. All the owner of the business has to do is make sure there are enough funds in the shop’s account and market the shop to its target audience.
These business models, however, have their own drawbacks. For instance, sourcing from websites like Taobao, which was the biggest online marketplace in 2019, could result in extended shipping durations due to their location. It could take at least two weeks for an order to travel from China to its intended recipient.
Issues like these could affect the working capital cycle and cash flows of the e-commerce shop. Changing the business model, or tweaking certain parts of it, could work to the enterprise’s advantage. However, the effectiveness of changing business models to improve working capital management varies on a case-to-case basis.
E-commerce platforms cover the fulfillment side of the business. However, the proprietor still needs to get involved in issues like financing and inventory. Most e-commerce businesses are either sole proprietorships or managed by a small team with less than 10 people.
Despite their size, e-commerce shops generate all sorts of information in a single day that the team needs to consolidate during decision-making sessions. There needs to be a workflow-based system in place to make sure that everyone is on the same page when collating and presenting the data. This system must integrate the workflows of each team member into a streamlined process that helps save effort and time.
With a streamlined system in place, it is easier for the business owner to make sound decisions based on timely and accurate data from the e-commerce platform. This is critical to managing inventory, for instance.
Business people love metrics. Metrics allow stakeholders and decision-makers to set a standard against which the company should be performing. Metrics and key performance indicators give entrepreneurs a clear picture of how the business is operating in certain aspects, including working capital management.
It’s important to identify early in the business’ operations the KPIs that could be used to measure performance. For working capital management, commonly used benchmarks are inventory turnover rates, the number of collection days, operating expenditures, revenues, and invoice terms with suppliers. Of course, entrepreneurs are free to include other KPIs as they see fit as long as they are relevant to working capital management.
It’s never a good idea for a small business like an e-commerce shop to pull out cash and make lump-sum payments. Doing so will leave a huge gap in the business’ cash flow. On the other hand, financing stabilizes the cash flow by providing funds that the business has to repay across several months. It preserves as much of the available working capital while also boosting it.
As mentioned earlier, e-commerce businesses may find it difficult to apply for traditional bank loans but there are alternative options now available. Payment can be handled using digital vs. traditional banks and we can expect this trend to continue These include:
· Merchant cash advances
· Revolving line of credit
· Business credit cards
· Small Business Administration loans
· Asset-based financing
Alternative loans help provide funds for equipment acquisition, debt refinancing, and business expansion, among others. Entrepreneurs only need to make sure that the business has enough liquidity and a stable cash flow before applying for financing. They also need to measure KPIs and make sales forecasts that determine what kind of financing they will need.
Much of any e-commerce business’ working capital gets diverted to operating expenses and debt repayments. This is normal because much of the business’ working capital at the start came through financing while operating expenses keep the company sustained through its day-to-day operations.
However, there are certain thresholds that could be considered as safe or essential, and levels of debt or expenses that can be considered as detrimental to working capital. Crossing these thresholds means that the business is spending too much money, and should consider cutting back on costs as well as debt. If left unmanaged, these could steer the business’ cash flow towards the negative side.
A careful review of the business’ expenses should be carried out regularly to find expenditures that are not necessary for its daily operations. These include employee perks that do not actually contribute to the company’s revenue-building efforts. These perks don’t have to be suspended indefinitely, but they can wait until the business’ cash flow is more stable and its revenue sources more numerous.
The pandemic has demonstrated how volatile the business landscape could be, and also how disruptive this volatility could be. The only way to keep this instability from affecting the business is to plan ahead. While it is impossible to foresee exactly what will happen in the future, entrepreneurs can instead identify possible risk factors and create plans to deal with the problem when it surfaces.
For example, e-commerce proprietors can try to identify alternative sources of inventory ahead of any possible disruption from their current vendors. Having an emergency plan specifically for this scenario lets the entrepreneur make sure that the business can order additional stocks despite the setback from its original supplier. This, in turn, helps the business avoid revenue loss and hits on its reputation coming from unhappy customers.
Proactive management can save the business from a serious crisis. For instance, COVID-19 has increased the demand for e-commerce shops because of the enforced lockdowns and quarantines. In this case, only businesses that had a contingency plan for surges in inventory and had enough cash flow set aside were able to answer that demand. That’s how some businesses managed to stay afloat despite the crisis.
Technological advancements are meant to make things easier, or at least more convenient, for all people, including entrepreneurs. E-commerce itself leverages existing technology like the Internet to open up more opportunities for proprietors around the world.
There are many ways that technology can help improve working capital management. As mentioned earlier, in-site analytics help entrepreneurs study the movement of inventory within their businesses. These data help business people make the right decisions in managing stock and creating promotions. Aside from that, technology also helps the team to collate information to understand the flow of cash within the company and determine whether there’s a problem that needs to be solved.
Technology can also transform the way businesses interact with their suppliers and vendors. Accounting software like Xero and Quickbooks make the process of settling invoices more convenient, and the payments more timely.
Effective working capital and cash flow management stand between the success or the failure of the business. Every entrepreneur must take time to study how cash flows within the company, and how much working capital he or she has to work with at any time. Paying attention to these two indicators helps make the proprietor one step ahead of both the competition, and the volatile market they are working in.