Working capital is a bloodline of ecommerce. There is rarely enough of it, and if you manage it poorly, not only can you lose some of the order spikes, but you may have trouble even fulfilling the orders that you already have.
In this post, we’ll discuss why working capital is so important and how to calculate it.
Importance of Working Capital
Working capital is essential for your ecommerce business because it represents the cash and other short-term assets that are available to cover day-to-day operations.
A healthy amount of working capital ensures that your business can meet its obligations — such as paying suppliers and employees — while also being able to invest in growth opportunities.
Proper management of working capital is vital, as it helps you:
- Maintain a positive cash flow
- Meet unexpected expenses
- Navigate seasonal fluctuations in revenue
- Take advantage of new opportunities and grow your business
Calculating Working Capital
To calculate working capital, you need to consider your current assets and current liabilities.
Current Assets include:
- Cash and cash equivalents
- Accounts receivable
- Prepaid expenses
Current Liabilities include:
- Accounts payable
- Accrued expenses
- Short-term debt
The formula for calculating working capital is:
Working Capital = Current Assets – Current Liabilities
By monitoring your working capital, you can identify potential cash flow issues and take corrective actions to ensure the stability and growth of your ecommerce business.
Remember to evaluate your working capital regularly to maintain a steady financial foundation.
Role of Cash Flow in Ecommerce
Importance of Cash Flow
Cash flow is the money coming into and going out of your business from different sources such as sales, inventory purchases, and expenses.
It is important for you to actively manage your cash flow so that you can make informed decisions and plan for your business’s future.
Cash flow allows you to maintain adequate inventory levels, pay for your regular expenses — like the cost of goods sold and operating costs — and invest in the growth of your ecommerce business.
By having a positive cash flow, you ensure that your business operates smoothly and has the ability to grow over time.
While having a strong revenue stream is important, cash flow is a more accurate indicator of your business’s financial health because it takes into account all the assets and liabilities that affect your cash balance.
You can sell $1 for $0.9 and have high revenue, but positive CF cannot be “fooled” so easily.
Managing Cash Flow
To effectively manage your cash flow, you should follow these practices:
- Monitor your cash flow regularly: Keep a close eye on your cash flow through financial statements and cash flow projections. This will allow you to detect any potential issues early, enabling you to make the necessary adjustments to keep your business running smoothly.
- Optimize your inventory: Strive to maintain the right balance of inventory that matches your demand. Too much inventory ties up cash in unsold products, while too little inventory can lead to lost sales opportunities.
- Manage your expenses: Make it a priority to regularly assess your expenses, prioritizing necessary and profitable expenditures while reducing any unnecessary costs. Be proactive in seeking out ways to save money, such as negotiating with suppliers for better deals or streamlining operational processes.
- Improve your accounts receivable: Ensure that your ecommerce platform provides a seamless and efficient payment process. But most importantly, make sure that your payment provider sends the money to your account ASAP.
Maintaining a strong cash flow will enable you to invest in the growth of your business while also ensuring that you are ready to handle any financial challenges that may arise.
Inventory Management in Ecommerce
When managing your inventory, you need to consider various costs such as storage fees, carrying or holding costs, and the risk of stock-outs. Properly managing these costs can contribute to improving your working capital.
Implementing inventory management software is a must as it can help you track stock levels, manage orders, and make data-driven decisions. Some benefits of using inventory management software are:
- Centralizing product information
- Automating the process of inventory replenishment
- Reducing human errors in inventory management
- Enhancing your supply chain visibility
Impact on Working Capital
By optimizing your supply chain, you can reduce the time products stay in storage, which lowers storage costs. Additionally, minimizing delays in restocking will help you prevent stock-outs, ensuring you won’t miss out on potential revenue.
Here are some ways you can improve your working capital through better inventory management:
- Accurate demand forecasting: By predicting product demand, you can anticipate which products need to be ordered or restocked, avoiding surplus or shortage.
- Supplier collaboration: Define optimal order quantities and order frequencies alongside your suppliers, ensuring a smooth and efficient supply chain management process.
- Inventory turnover ratio (ITR): A high ITR is desirable because it represents a faster inventory movement and the selling of goods at a quicker pace, which can boost your working capital.
By optimizing your supply chain and using inventory management technology, you can stay on top of inventory costs and ensure your business remains profitable.
Determining Working Capital Needs for Ecommerce
When running an ecommerce business, you need to consider fulfillment expenses as part of your working capital needs. These expenses include costs for receiving, storing, and shipping products to your customers. To calculate these costs, you should consider the following:
- Warehousing and storage costs: Understand the fees associated with leasing a warehouse or using a third-party fulfillment service like Amazon FBA.
- Packaging and shipping costs: Determine the costs of packaging materials, and estimate the average shipping costs based on the size and weight of your products.
- Labor costs: Include the wages for employees responsible for order fulfillment.
Marketing and Advertising Expenses
Having a successful ecommerce business requires investing in marketing and advertising. Allocate some of your working capital to cover these expenses:
- Paid advertising: Allocate funds for sponsored ads on platforms like Google and Facebook/Meta.
- Influencer marketing: Consider the costs of partnering with influencers to promote your products.
- Email marketing: Factor in the costs of offering discounts and other promotional efforts.
Seasonal Sales Fluctuations and Its Impact
Ecommerce businesses often experience seasonal sales fluctuations. Plan for these fluctuations by adjusting your working capital needs.
- High-demand seasons: Increase stock levels during hectic shopping periods such as holidays.
- Low-demand periods: Reduce inventory during quieter times to avoid tying up your working capital in slow-moving stock.
Payment Processing Timeframes
You receive funds from customers’ payments after a processing period. Be sure to include the time between sales and receiving funds in your working capital plans:
- Credit card processing: Allow 1-3 days for transactions to be approved and funds transferred. This can take longer with Stripe and other popular payment providers, so account for that as well.
- Other payment methods: Account for other processing times such as extended time frames for bank transfers and PayPal transactions.
Cash Reserves for Unexpected Expenses
Finally, it is crucial to maintain cash reserves for unexpected expenses that may arise:
- Product returns and refunds: Have enough cash on hand to cover the costs of processing returns and issuing refunds to customers.
- Equipment maintenance and replacement: Be prepared to cover costs from updating or replacing equipment such as packing tools, warehouse equipment, etc.
Ecommerce Growth and Working Capital
Impact of Growth on Working Capital
As your customer demand increases, you’ll find the need to expand your product offerings and improve customer loyalty.
High growth rates can lead to a higher need for working capital. This improved cash flow is necessary to support expansion, meet new demands, and maintain smooth operations.
As your ecommerce business grows, you may face several challenges related to your working capital:
- New products and inventory: As you expand your business, you may need to invest in new products, inventory, and suppliers to meet customer demand.
- Staff and resources: To accommodate growth, you will need to hire new employees and allocate resources strategically to manage increased workload, ensuring optimal productivity and enhanced customer experience.
- Marketing and advertising: As you introduce new products and enter new markets, increased marketing and advertising spend can help reach new customers and maintain customer loyalty.
- Technological improvements: To keep up with your competitors, you may need to invest in advanced technologies to streamline your operations and improve customer interactions.
Capital advance: Access to capital advance facilities can help you overcome unforeseen circumstances (such as an economic downturn or supply chain disruptions) that might affect the short-term liquidity of your business.
Management of Working Capital in Ecommerce
In the ecommerce industry, managing working capital efficiently is crucial for your business’s success. You need to optimize three key areas: efficient inventory management, negotiating favorable terms with suppliers, and monitoring and forecasting cash flows.
Efficient Inventory Management
To optimize your working capital, it’s essential to maintain an efficient inventory management system. Track your inventory levels closely and use data analysis to forecast demand. This will help you minimize stockouts and overstock situations. Implement the following strategies for improved inventory management:
- Utilize a real-time inventory tracking system to monitor stock levels
- Analyze sales data to identify top-selling items, and ensure sufficient stocks
- Implement regular stock audits to identify discrepancies and manage obsolete inventory
Negotiating Favorable Terms with Suppliers
Establishing strong relationships with your suppliers can result in negotiating better payment terms, positively impacting your working capital. Consider implementing these strategies:
- Pay your suppliers on time to build trust and maintain positive relationships
- Request extended payment terms where possible to keep cash on hand longer
- Consolidate suppliers to increase your purchasing power and negotiate lower prices
Monitoring and Forecasting Cash Flows
Cash flow management is critical in ecommerce to ensure you have enough working capital to fulfill orders, pay suppliers, and cover operating expenses. Keep a close eye on your cash flows and forecast future funds with the following approaches:
- Utilize accounting software to generate regular cash flow statements
- Analyze financial data and trends to identify patterns and areas for improvement
- Implement cash flow forecasting to plan for anticipated expenses and to better allocate resources
By focusing on these three areas, you can optimize your ecommerce business’s working capital and secure a strong financial foundation for growth. Remember, efficient inventory management, favorable supplier relationships, and accurate cash flow monitoring are essential components of successful working capital management in the ecommerce space.
Sources of Ecommerce Working Capital
Since we established why you need working capital and all the areas where you will be spending it, it is time to have a look at options where you can actually get it:
Internal sources — profits
Profits generated from your operations are the most readily available source of working capital.
By reinvesting your profits, you can grow your business without taking on additional debt or diluting ownership.
To optimize your profit generation, focus on controlling costs, increasing sales, and managing inventory efficiently.
Short-term loans are popular options for ecommerce businesses seeking to cover temporary cash flow needs.
These loans typically have terms from three to eighteen months, and interest rates are based on your creditworthiness and business performance.
To obtain short-term loans you can approach banks, credit unions, or private lenders.
Line of credit
A line of credit (its short-term form is referred to as an overdraft) is a flexible financing option that allows you to access funds as needed up to a predetermined credit limit.
This financing tool can help you manage your cash flow fluctuations and cover unforeseen expenses.
When considering a line of credit, do your research and compare fees, interest rates, and eligibility criteria from various financial institutions.
With invoice financing, a lender advances you funds based on the value of your unpaid invoices. This can be an effective way to bridge the gap between invoicing your customers and receiving payment, especially for businesses with lengthy payment terms. When considering invoice financing, weigh the fees and interest rates charged by various providers to find the best fit for your business needs.
Trade credit refers to the credit extended by suppliers, allowing businesses to purchase goods or services on account and pay for them later — usually within 30, 60, or 90 days.
By negotiating favorable payment terms with suppliers, ecommerce businesses can effectively manage their cash flow.
Establishing a good relationship and track record with suppliers can lead to extended payment terms, allowing you to keep cash in the business for longer.
Merchant cash advances
A merchant cash advance provides ecommerce businesses with an upfront sum of money in exchange for a percentage of future credit card sales. It’s particularly suitable for businesses with significant credit card transactions.
Although the access to funds is quick, merchant cash advances often come with higher fees and interest rates compared to traditional loans.
Platforms like Kickstarter and Indiegogo allow ecommerce businesses to raise small amounts of money from a large number of people.
While traditionally associated with product launches or creative projects, these platforms can also provide working capital.
However, businesses usually need to offer a product, service, or incentive in return for the funds.
By selling a stake in the business to investors or venture capitalists, ecommerce businesses can secure significant capital. This can provide substantial funds and potentially valuable business expertise and connections; however, it does mean giving up a portion of ownership and, in some cases, control.
Remember, when seeking financing, it’s crucial to understand the terms, costs, and potential impacts on your business fully.
Compare offers, and consult with a finance professional or even a lawyer if needed. While solving working capital is definitely a pressing matter, take your time to consider your options and pick the best one for your situation.