When starting a Shopify store last year, one of my most crucial takeaways was the amount of profit I was giving away by not understanding the concept of inventory management. Going hand-in-hand with that, I also didn’t realize how restraining my clash flow had become by mistiming and mismanaging my inventory.
In turn, I had cash flow issues that were compounded by my lack of inventory controls. Here’s the kicker:
I was a CPA (Certified Public Accountant) by day and an aspiring eCommerce entrepreneur by night, and I was still falling into the same pitfalls I see my fellow entrepreneur friends were falling into.
Inventory can be a tricky aspect to take into consideration for eCommerce companies. You’ll want to make the right choices when selecting your inventory in order to avoid costly mistakes.
With this guide I hope to provide eCommerce sellers with a few tips on how to keep more profit in their business and improve cash flow management, while still maintaining an adequate inventory turnover rate and a profitable long-term business that can withstand the test of time.
Let’s get into it!
Tip #1: Understand the Key Terms of Inventory Management and Cash Flow
There’s nothing more important when diving into a new subject than understanding the key terms. In this case, cash flow and inventory management are crucial to know before you dive into any further reading or information gathering.
- Cost of Goods Sold- COGS is the total cost that a company paid to produce their inventory. In other words, this is what you’re paying for your product before it even hits shelves or gets shipped out. Check out this blog post here if you want a more indepth look into COGS!
- Inventory Turnover Rate- Your inventory turnover rate (ITR) refers to how many times per year your cash flow from sales exceeds cash spent on COGS. This will allow you to bring in new products and replenish old products as they deplete. The higher your ITR number, the better off you are!
- Lead Time- The time it takes from initiation to completion of a process. In the fulfillment industry, lead time is how long it takes from order notification to shipment.
- Order Lead Time- The lead time that starts once you’ve received an order through your online store. In other words, how long does it take for a customer who has made their purchase to receive their item?
- Reorder Point- Your reorder point is when cash flow begins to go south because inventory levels are so low they can’t be replenished on hand. You want this number as close (or lower) than possible without going too far in which cash flow would dip into negative territory! This helps ensure that there’s always enough cash coming in each day while also keeping stock high at all times.
- Average inventory- The mathematical representation of how many days worth of cash flow you have on hand. So if your cash flow was $1000 and you had an average inventory of 30, that means at any given moment there’s enough cash in inventory for your business to last a little over three weeks (30/1000=0.03)
- Economic Order Quantity (EOQ)- The number of items you should order at one time so that cash flow stays stable and manageable.
- Receiving Report- The receiving report will show all incoming shipments on hand inventory levels.
- 3PL– A third party logistics company (or “third party logistic provider”) is a business that contracts with companies to handle their shipping and distribution.
- First in First Out (FIFO)- The FIFO approach is what you’re going for when cash flow is low and inventory levels are dwindling. You want to use this method if your cash lead time, or the amount of time it takes for a customer who has made their purchase to receive their item, exceeds your reorder point.
- Last In First Out (LIFO)- The LIFO approach is what you’re going for when cash flow leads time, or the amount of time it takes for a customer who has made their purchase to receive their item, exceeds your reorder point.
- Inventory Management Software- Inventory management software, or “inventory management system,” is software that helps you track and manage cash flow, inventory levels, cost of goods sold, average inventory level, and more.
- Lead time demand- When cash flow decreases because inventory levels are so low they can’t be replenished on hand. The number needs to be as low as possible without going into negative territory. This helps ensure that there’s always enough cash coming in each day while also keeping stock.
- Reorder point- The amount of inventory that you need to order in a certain time period, so that when it runs out you will have replenished your stock. You can estimate your reorder point using the following formula: how quickly customers are buying and the quantity/purchase by the customer.
Moving into Cash Flow, listed below are some introductory terms that will help you understand related concepts:
- Statement of Cash Flow- A document that tells you how much cash your business has received and spent over the course of some time period. A cash flow statement reports on cash inflows, such as receipts from sales or income generated by investments; and outflows, which include expenses incurred to run the company.
- Operating Cash Flow- A measure of cash that’s coming in and going out. It tells you how much cash your business has on hand at any given moment.
- Cash Flow from Operations- Cash your business has that’s coming in. It includes cash receipt, income generated by investments and other sources of cash.
- Burn Rate- The rate at which a business is losing money. This number needs to be higher than cash coming in, or the company will have negative cash.
- Cash Flow Forecasting- Cash flow forecasting is a cash management technique that can help you accurately predict cash inflows and cash outflows to better plan for the future.
Tip #2: Focus on your most popular products
It’s a mistake to try to add as many product lines as possible to your store without first considering how it is affecting your gross margins. It’s also a mistake to try and offer wholesale pricing on products that don’t sell well. You’re better off focusing your efforts on what you do best, get cash flowing from those items, then reinvest in other goods as needed.
The top performing eCommerce stores are usually the ones that understand these 4 key points about their business model. Once you have learned these, you will see instant improvements:
- You can identify which product lines are your best sellers and know when to discontinue others that drag down your Gross Margin %. You use your clean bookkeeping to identify trends in financial statements.
- You are not afraid to invest in other products when you are cash-strapped.
- You have a good understanding of cost, margin and all the numbers that go into your business model, so you can keep track of what’s going on at any point in time.
- You work with a 3PL and fulfillment centers that are truly invested in your success.
eCommerce is complicated enough without trying to juggle more than you’re capable of. The key is to test different product variations to find market fit and scale them to meet customer demand.
Tip #3: Streamline your supply chain
Small businesses that are cash-strapped often make the mistake of trying to be everything to everyone. This is a surefire way to get stressed and cash flow poor. Focus on your niche, find suppliers who can provide you with what you need at an affordable price point, then scale up within your wheelhouse as needed!
Here are the top 8 key factors to focus on to Streamline Your Supply Chain:
- Perform Cycle Counts at your fulfilment center so you understand exactly what you have on hand.
- Predict your inventory turnover and understand the impact on your cash flow.
- Prepare for Peak Production Periods so you have the inventory to meet demand.
- Monitor Your Supplier’s Lead Time to make sure they can keep up with order volume. Sometimes suppliers are not able to foresee peaks in orders and will need help from you or other vendors through a “piggybacking ” arrangement.
- Know the Availability of Your Suppliers so you can plan ahead and have contingencies if a supplier goes out of business or is suddenly no longer able-to-supply your product.
- Use Supplier Dashboards to get the most accurate inventory counts and cycle estimates.
- Focus on Your Niche – Find suppliers who can provide you with what you need at an affordable price point, then scale up within your wheelhouse as needed!
- Think of Inventory Management like Accounting – invest in it if you want a future for your business.
Tip #4: Clean Bookkeeping is crucial for your eCommerce Business
Clean bookkeeping will help you get back on top with your cash flow, making sure you don’t lose any money unnecessarily. On average, eCommerce owners that have clean books vs those that have not, often have an additional 10-12% additional profit to look forward to at the end of the year. For a business that is doing 1M a year in Sales and netting $200,000, clean books can boost that figure to nearly $300,000!
How would Clean Bookkeeping improve my business operations?
- Identifying tax deductions
- Detecting fraud and banking errors
- Understanding the state of your business
- Recognizing potential areas for improvement in Accounting practices
- Monitoring cash flow and profitability
- Identifying trends that might affect future sales
- Ensuring legal compliance with Accounting Standards
- Most importantly, clean bookkeeping provides peace of mind – knowing what’s going on financially so you can focus more time on scaling your business to the moon.
Now that you understand why clean bookkeeping is so important, let’s dive into how that can be attained.
6 Steps to Clean Bookkeeping Habits
- Ensure your personal and business transactions are kept separately.
- Choose a bookkeeping software that is right for your business.
- Create a chart of accounts.
- Record and Reconcile your data.
- Learn to interpret your datapoint in order to create a monthly recommendation report for your brand.
- Create “Investor Level Financials” that you can present to bankers and lenders in order to exit the business at the valuation you deserve.
If a time comes when you decide to sell your company, it’s important that all of your business data is accurate. Investor level financial reporting will provide investors with excellent insight into what they’re buying before they purchase shares in your brand. Investors are most interested in understanding the “real” value of your company, and will make decisions based on this information. We also have a “Ecommerce Bookkeeping for Dummies” blog that further spelled out some of the key things you should look for in your growing business. Check it out here!
Pro Tip: You must remember, your bookkeeping is only as good as the financial data you input. Be sure to keep your entries as detailed and accurate as possible.
Tip #5: Look ahead: Perform a Cash Flow Forecast and never have cash flow issues ever again.
Cash flow forecasts are an essential tool for any eCommerce business owner looking to save on stress and make more informed decisions. A proper cash flow forecast will tell you two very important things:
- Cash needed for continual operations
- Opportunities for reinvestment
Let’s talk about each of these topics in detail.
Cash needed for continual operations
An important thing to know is that cash flow forecasts are about predicting your future. To do this you need a best guess and some assumptions for how your business will perform in the near future. The concept of “burn rate” is key here, as it is the amount of cash you’ll need to sustain your business’s operations on a monthly basis.
If you are interested in learning more about the concept of Working Capital and Cash Flow Forecast, check out our guest podcast spot on the Amazon FBA Podcast!
If we were projecting our cash-flow forecast at a time when money was tight and funds were low, it’s important that we first do some cost containment in order to reduce our burn rate. One way of doing this is to identify and decrease what we call a “sin”: an expense that doesn’t provide any value. For example, if you have office space with high rent but your team only needs half the square footage for their work then it would make sense to downsize at this time so as not to overburden ourselves in times of cash constraint.
Opportunities for reinvestment
The final thing to know about cash flow forecasts is that they give you an opportunity to make more investments in your business and see exponential growth! In our example, we had $3600 left over from the monthly expenses after paying the “burn rate” of operations so this means that there are opportunities for reinvestment. These investments can be made in various areas of your business – such as an additional marketing campaign, a new staff member to increase production or even just taking the time off that you need for yourself!
When you know where your cash is coming from and going to, it allows for better decision making in regards to what opportunities might be available.
As you can see, there are many ways to make your eCommerce business more profitable. The first step is understanding the importance of good inventory and cash flow management.
In order for inventory and cash flow to work well together, you need a clean bookkeeping system that is updated on a monthly basis. Having the proper accounting knowledge will keep your business running smoothly and profitably. A cash-flow forecast will allow you to predict what opportunities might be available in the near future; an ongoing cash flow forecast will allow you to make better decisions. Accounting is an important part of any business, whether large or small; it can be the difference between success and failure.
Still stuck on inventory turnover and cash flow? Reach out to us today!
By Alan Chen, CPA
Alan is a Certified Public Accountant and one of the founding partners of FreeCashFlow.io, where they are focused on helping online and eCommerce business owners with accounting, consulting, and tax services.
Along with his partner Stanford Dai (CPA), they have over 20+ years combined experience working in Audit, Accounting Compliance, and Tax for multinational companies such as EY, Riot Games Disney, and Paramount Pictures.
They offer an “all inclusive package” to help eCommerce businesses continue to grow and scale without having to worry about any compliance or tax issues stifling their growth. If you have any questions or inquiries you want to know more about, feel free to reach out to Alan at [email protected].
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