Why a growing eCommerce business is a pain and how to deal with it
Updated: Mar 9, 2020
Picture this dream scenario: your E-commerce business is growing and your product is getting great reviews and consistent traffic.
What could possibly go wrong? Enter Cash Flow.
According to Shopify more than 80% of businesses fail due to poor cash flow management. For example have you ever been in the situation where you were hoping to get your money from Amazon to restock on time, then wasting your margins on faster shipment options? Or, even worse, getting to the feared out of stock scenario. Better cash flow management is your number one secret in growing a healthy and valuable business.
How suppliers use you to finance themselves
Imagine you are a Seller based in Greece, making $500,000 in sales a year in the Home & Kitchen category, sourcing from China and selling on Amazon US. Your cash troubles begin with the suppliers, often not eager to offer you better payment terms. Why? First, because there is a risk of you not paying the supplier once the production is complete. And second, the supplier also needs money to get the raw materials and pay their employees. What we see often is a compromise: worse product quality or harsher payment terms. Once you build a stable relationship with your supplier, you should aim to negotiate your payment terms.
Do not accept 100% prepayment at any time, you are not your supplier's bank.
The first batch might require 50% prepayment, but going forward it’s easy to move it to 30%, or even to 0% prepayment. An alternative is to negotiate your prices down while keeping the payment terms unchanged. Even though it might seem similar, the impact on your bottom line can be substantial. Why? Because you could use that capital to get a bigger gain than the price discount from your supplier, for instance by boosting your ad spend while waiting for your new inventory. If you haven’t done your math properly, this can become a cheap source of funding for your supplier, rather than a growth opportunity for you.
Stock-up like a pro
The second problem you have is logistics. If you constantly risk running out of stock, you have to send your cargo by air, which will eat heavily into your margins. A better decision is to get up to 3-4 months in inventory and use a slower, but more financially efficient sea freight option. If you use Amazon FBA, note that keeping all of that inventory in Amazon warehouses could be quite expensive. We would suggest keeping it in an external warehouse and sending batches to FBA.
You need to carefully balance the savings from external storage and the costs of batch delivery to FBA.
Try to use full pallets, as sending cartons can be twice as expensive for the same volume. If you are sending multiple pallets, a good logistics provider will make sure they are stacked, adding to your savings in delivery to FBA. An alternative solution we see being used is to keep the bulk of the inventory in the market of origin (e.g. China). In this case though you can’t react as fast to a ramp up in sales as with a warehouse at the destination market, but it fits well a business with stable sales numbers.
How to find inventory funding
To benefit from the above, you need to get more inventory. Easier said than done, as it’s a circular problem. You need more inventory to improve your cash flow, but you need cash flow to get more inventory. How can you get there?
We will go through three alternatives, each with its own pros and cons.
Banks and Alternative Lenders
If you have an established business in a developed country, banks might be a good source of funding. You need several years of business activity, offer personal guarantees and spend a lot of time for the application process. Unfortunately, most often this will not fit an eCommerce business.
Your business is online, your product is relatively new, and it's often moving across borders. Banks are not ready to deal with such complexity.
Another downside of getting loans from banks and alternative lenders is their impact on your credit score, even if you don’t get the money. Despite these cons, if you have the chance to get a cheap SBA loan, go for it, as diversification in your funding sources is very important.
It's always great to have business partners you can rely on. First of all, you split the risk and operational effort. And as a perk, you'll feel less lonely in your business journey. Adding investors though is not always the cheapest funding option. In the eCommerce world, we have seen that only few realize how equity is a very expensive source of capital.
Equity capital should not be required for your working capital needs, as there are much cheaper solutions for that.
When should you use investor money (equity)? When you are launching or when you want to scale your business towards the big Direct-to-Consumer brands. Use equity for the risky part of your business, and leave the cheaper inventory funding to something that won't cut into your margins.
Here's a simple numeric example. You have $1.2m in annual sales. You pay your supplier $320k per year (i.e. $80k every 4 months). Add logistics, ads, eCommerce platform fees, and your net profit is about $200k. Let's say you can get an investor on board at a 2x valuation ($400k), which means she would give you those $80k in working capital for 20% of your equity. That's 20% of your net profits, every year, forever. With funding, you can cut this in half. For example, if you pay with a simple markup of 2% over your retail price ($24k), this translates into 12% of your net profit. And your business is still entirely yours, forever.
Inventory Funding, or "buy now, pay later...much later".
Having been in the Seller's shoes, we came up with an alternative solution to the cash flow problem: "let somebody else buy your inventory for you".
The big boys and girls of eCommerce have been doing it for years, calling it Trade Finance, and now you can, too.
This solution offers numerous benefits, such as:
Affordability and transparency. Many of the Alternative Lenders offer rates that can easily get close to a 50% cost of capital. They get away with it through hidden fees and unclear term-sheets. With our solution, you always know your fee ahead of time.
No requirements for a U.S. entity or an entity at all: eCommerce is a global business and can be based virtually anywhere. Whether you are based in a developed or an emerging market, you deserve the same affordable capital, as long as you have a great product.
No credit checks or personal guarantees. We care about your eCommerce business and the quality of your product, not about your student loans, mortgages or a collateral such your house.
In this post, we explained how to alleviate cash-flow problems of an eCommerce business. To sum this up, I will quote Greg Elfrink's 2020 report on buying and selling eCommerce businesses:
"The more you decrease your spending in the supply chain, the larger the ripple effect you’re going to make when it comes to increasing your margins”.
More abundant, stable and cheaper inventory funding will substantially increase your margins through:
Leverage with the supplier for better quality or lower price.
Using sea versus air freight (and going towards FCL versus LCL, once you scale).
Stocking up on inventory and sending to Amazon FBA only when needed, to avoid the growing Amazon FBA warehousing fees.
Get in touch and we'll do our best to help you scale your business through NimbleSeller inventory funding.