When you first start off your business you might have invested every single cent you own into your first delivery of inventory. But as your business grows, generates profit, and gets significant expenses, the issue of cash flow management becomes more important.
A common question among eCommerce founders who have begun to get some success is ‘How much cash in the bank should I have?’
It is an impossible question to answer because it depends on every variable in your business, such as your inventory requirements, revenue growth, expenses, ability to cut expenses, your risk tolerance, and the likelihood of cash flow variations.
I have tried to explain all of the aspects of cash in the bank that you need to think about, but first of all I recommend setting a minimum cash limit. When planning out your cash flow for the month or the quarter, then this limit should halt all expenses so that you can keep your business alive.
Let’s get started.
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eCommerce Cash Requirements
eCommerce businesses consume cash without remorse. This is mostly due to their ability to grow quickly.
Let’s use an example to explore this idea.
Month 1 – $1000 in Revenue with a 20% profit margin gives $200 in profit. You need to replace $500 worth of inventory.
Month 2 – your store gets mentioned in a local newspaper which gives you an unexpected boost in sales up to $3000. This means you need to replace $1500 worth of inventory. But you only have the $200 cash from last months profit. So you can’t fulfil your new orders and lose out on that revenue.
This is when store owners need to decide whether they take on outside capital or whether they slow their growth.
But it gives an idea of how difficult it is to manage your cash.
How Much Is Too Little?
Simply – if there is a risk you will run out!
If you are worried about not being able to pay your upcoming bills then you should reduce your spending and hold more cash in the bank. This may seem like it will slow your growth – which it will – but if it gives you the peace of mind so that you can make better long term decisions then it is worthwhile.
There is no finish line when it comes to eCommerce, and it is not a race against the latest online marketing guru. You can take it as slow as you would like to feel comfortable in the financial position of your business.
If you have employees then you will want to run your cash more conservatively. If you primarily use outsourced services that you are comfortable shutting down when cash becomes tight then you can run a bit looser.
Also consider whether you have any lending available whether that is credit cards, business loans, or other sources of funding.
If Covid was to hit next week would be comfortable with the amount of cash in your bank account? If not, then you might want to re-evaluate your targets.
How Much is Too Much?
The other end of the scale is having too much cash in the bank. Is there a better use for that money to improve your business?
Here are a few ideas that might be a better way to spend excess profits:
- Invest in more inventory for new product
- Invest in more inventory for existing products that often sell out
- Invest in new content, whether that be buyer’s guides, instructions, photography, SEO, or emails
- Invest in copywriting to increase the conversion rate of your product pages
- Outsource some painful jobs that take up all of your time – this could be customer service, market research, writing, or creating newsletters
- Purchase new equipment that will improve the manufacturing process
- Hire a brilliant new employee
There are an almost infinite number of ways to improve your business – either in terms of growing revenue, improving the customer experience, or reducing expenses.
One of your biggest expenses will be inventory. This is effectively cash that gets locked up until you can sell it. As such it comes a key component of your cash flow management strategy.
How much inventory do you need, when do you need to order it, and how much cash it will consume need to be forecast with enough warning to achieve your cash targets.
This can be a decision between how much cash you want on hand, how much cash you have locked up in inventory, and how much working capital is available total for inventory in the warehouse and being manufactured.
Cash as a Ratio of Expenses
Microsoft (a very successful business in their own right) suggest that you keep three to six months worth of expenses in cash.
This is particularly important if you have employees or other critical expenses.
There are some expenses that can be eliminated if times become tough. The key here is to differentiate between true expenses and re-investing profits.
Expenses are things that you need just to run your business – packaging, shipping, employees, accounting, etc.
Re-investing your profits are things that will grow your business – new advertising campaigns, new product lines, press, etc.
Always keep these two seperate in your mind, so that when a cash crunch happens you can easily start to change how you re-invest your profits.
You should always be trying to minimize your expenses.
Working capital is defined as the difference between your assets and your liabilities excluding liquid cash. In reality for eCommerce this is normally defined as how much cash is locked up in manufacturing products that is not available in inventory to sell.
If you are looking to get a big order from your suppliers for Black Friday or testing new product lines then a huge amount of your cash can get locked up as working capital.
Just make sure you are aware of the impact this can have on your cash in the bank and inventory available to sell – which in turn can hurt your revenue and incoming cash flow.
Plan for Emergencies
I mentioned above, what would happen to your cash flow if Covid or equivalent hit your business and had a significant hit to your cash flows. Do you have enough cash or credit available for your business for survive.
While the entire eCommerce marketing community is focused on growth, the one thing more important is making sure your business is still around next year.
There are all kinds of emergencies that could happen that you should consider:
- Your supplier shuts down
- Your key employee quits
- Your insurance payment increases significantly
- Your delivery vehicle breaks down
- Your website gets hacked
- Your fulfilment company increases its costs
On the other side of the coin, if you need to hold so much cash in the bank to survive every possible emergency that your business will never grow to your target side to provide you with your target salary, then what is the point in having a business?
What about Seasonal Businesses?
It becomes particularly complicated if you have a seasonal business. If you sales go through the roof around Christmas, or during the summer, or just before Mother’s Day, then you will need to have some high quality forecasts about your revenue, your expenses, and your cash flow.
You will want to hold more cash in the bank than a stable business so that if your forecasts are wrong you don’t run out of money before your peak season.
You can always invest more money afterwards if you end up with too much, but you can never recover from not having enough.
Cash flow and inventory management is a complicated topic that requires forecasts that will always have errors. It is a topic that can never have a correct answer because it depends on your individual risk tolerance and growth targets.
My advice is to build yourself a forecast on revenue, inventory, and cash in the bank at least over the next month. If you are a seasonal business then you will want to do a 12 month forecast. The larger your business gets the longer in advance you will need to forecast.
Then use these targets to manage your business on a day by day basis. You can always go in and change the forecasts as things change, but at least you have spent some time thinking through the issues.