This is a guest post by Anand Srinivasan. Anand is the founder of Hubbion, a suite of free business apps and resources.
Struggling to make payroll? You are not alone. According to one study, nearly 82 percent of businesses in America fail because of cash flow issues. Ironically, the more successful a businesses is at selling products, the more likely it is to face cash flow issues.
Let us understand why. But before we get there, it is important to understand what cash flow is, and why it is significant. In layman terms, cash flow is essentially the money that is in your bank account after you subtract the money that goes out. For instance, if your customers have paid you $50,000 for all the products you have sold and you, in turn, pay your suppliers $30,000, you have $20,000 in your bank. You are thus cash flow positive by twenty grand.
But things are not this simple in the real world. When you are just starting out as a bootstrapped entrepreneur, you may purchase a limited quantity of products from the supplier and sell them to your customers for a profit. Your margins in this case are lower; even unsustainable. But if you have sufficient capital to tide over the period between buying from the supplier to selling to the customer (also called the working capital), then you are likely to end the transaction with a positive cash flow.
The challenge in the above example is making sure that you have enough working capital. But as your business grows, it no longer makes sense for your business to pay your suppliers for each procurement. The volume of purchases increase and businesses request their suppliers to invoice them at the end of each billing cycle. This makes accounting easier.
But customers do not pay immediately either. If you are selling your products to another business, then they tend to buy products from you on credit (similar to the arrangement you have with your supplier). If your supplier has a 45 days credit period and your customer promises to clear invoices within sixty days, then you are putting yourself in a position where you need to pay your supplier before you get money from your customer. Cash flow problems as these are not one-off and is a reason why so many businesses fail.
Things get more complex in the eCommerce world. For one, chargeback is a big issue for online payments. According to one study, nearly 8 in 10 customers tend to file for chargebacks with their bank even before they exhaust all other options for dealing with the seller. In other words, your customers may refuse to pay for a product for simple reasons like the product not working as desired or them not requiring your product any more.
Also, unlike in the real world, your customer does not get to ‘touch and feel’ your product before they pay for it. Not surprisingly then, the number of returns and replacement requests are significantly higher online. As a seller, you are responsible for handling the logistics - such issues can cause a significant dent to your cash flow.
Let us take a look at few ways an eCommerce seller can overcome the cash flow issues in their business.
One of the most obvious ways to fix the cash flow issues in your business is by remodeling your business to address the pertinent issues in the process. At a fundamental level, this essentially requires you to make sure that your credit period with your customers is shorter than the one you have with suppliers. This way, you get paid by your customers first and this money can then be used to pay your suppliers back.
This is easier said than done. The model only works if you are a major seller targeting retail or low-end business customers. In such a scenario, you have leverage both over your supplier and the customer and can thus dictate the credit period on either side.
As any successful entrepreneur will tell you, the success of your business depends on the credibility of your supplier. Trusted suppliers are hard to come by and often dictate their credit periods. Similarly, you earn healthy profits by selling to high value customers. Such customers have the upper hand when negotiating credit cycles.
One way to overcome this is by reinventing your business model. Dropshipping is a popular choice among eCommerce businesses since it completely removes the supplier-end of the transaction. With dropshipping, you no longer have to deal with stocking inventory from the supplier and fulfilling them to the customer. Instead, you serve as the white-labeled reseller of the supplier’s product and are merely responsible for collecting money from the buyer, keeping your commission and transferring the rest to the supplier.
This model is extremely popular among eCommerce entrepreneurs since it virtually guarantees you a positive cash flow. The downside of this strategy is that your brand and credibility is now in the hands of a dropshipping supplier. A failure on their part to honor a delivery can adversely affect your credibility. If you use third party tools like AliExpress to find a dropshipper, make it a point to partner with someone who has a feedback rating of at least 95% with a feedback score of over 2000.
Businesses that contribute to a larger volume of the supplier’s business tend to get a better deal. Growing your business to reach larger turnover is indeed the dream of many an entrepreneur. There is however a catch-22 dilemma here. As noted earlier in this article, businesses that increase their volume of trade often need higher working capital to get by. This brings their profitability down and can even lead to bankruptcy.
The way to fix this is by raising capital through a healthy mix of debt and equity. Infusing capital into your business by giving up on equity is not a sustainable idea since it brings down your leverage within your own organization. However, equity based capital financing is safe from an operational perspective. It is a good idea to give up equity to raise funding that will be used to build capital equipment like manufacturing plants, warehouses, etc. These investments are quintessential to a growing organization. Also, these investments take time to show results. Raising money through debt can be quite risky.
However, if you plan on scaling up through massively expanding your sales network, then debt is a better bet. By raising debt, you can retain complete ownership of your business. Also, expanding your customer base tends to bring increased revenue flow at very short notice. This makes such expansion viable through the debt route.
There are many ways to raise debts. The challenge with traditional bank based lending is that it restricts the power of approval to a select few individuals. That, combined with the time it takes for approval makes it a difficult proposition for entrepreneur who need working capital loans.
Services like Bitbond are ideal for short-term loans like those required to cover your working capital deficit. These are loans that are lent for a short duration of anywhere between a few weeks to a few months. Also, these are relatively quicker to get approved and help you seek out for a loan from thousands of lenders globally.
This is especially helpful for eCommerce businesses since the lending process is completely online; just like your business. Traditional lending channels are wary of businesses that have suppliers and countries located in different countries.
Logistics is a huge bottleneck for eCommerce entrepreneurs. The shipping charges on popular providers like UPS and FedEx is not exactly nominal unless you are a major player. If you are a seller on Amazon, you may be interested in using their FBA feature. FBA, or Fulfillment By Amazon is a feature where you pay the company a small fee each month to hold and process your shipment. In other words, you do not have to stock your inventory. Instead, they may be shipped to Amazon for fulfillment.
This facility is especially useful for small and fast moving products. Large products, or those that do not see a huge turnover can cost a lot in terms of holding and processing. It is a good idea to dropship such products directly from your supplier to the buyer.
One lesser known feature with Amazon is their Multi-Channel-Fulfillment policy. MCF makes it possible for eCommerce entrepreneurs to hold their inventory and process their orders through Amazon even if you do not sell directly on the website. That is, you may process your orders on your own site or another eCommerce platform and still process these shipments through FBA.
There are a few points to note here. MCF can be quite lucrative compared to FBA since you may be paying an additional seller fee to Amazon for products sold through the website. But it is also worth pointing out that Amazon charges extra for stock removal or repackaging - these are fees you may incur if your goods expire or the customer needs a replacement. You may also explore alternatives to MCF like FedEx Fulfillment or a local freight forwarding company if the price is right for your product category.
From an eCommerce entrepreneur’s perspective, taking fulfillment off your shoulders and handling them through a third party can be a great way to fix your cash flow woes. This is primarily because inventory management is a highly capital-intensive function. This pushes your business into the red even before you start shipping your first product. Holding it through a third party gives you a reliable fixed cost estimate for every product you stock. It is easier to calculate the margins per sale through this process.
Third party fulfillment however has its own disadvantages, especially if you have an unreliable sales cycle. In such cases, your product may incur unreliable holding costs from your fulfillment partner that may backfire and impact your cash flow.