Several strategies for managing operating cash flow can really help you avoid financial issues in your business. If you implement them early on, you can increase your chances of remaining lucrative over the long term.
What is Operating Cash Flow?
Your business’s operating cash flow is how much cash it generates from normal operations. That is, after paying its operating expenses and adjusting for non-cash items. It shows how well the business can generate cash from its day-to-day activities. It is also, therefore, a key indicator of the business’s financial health.
Operating cash flow includes:
- Net income, or the profit your business makes after deducting all the business expenses.
- Non-cash expenses, or those that don’t involve the actual outflow of cash, like depreciation and amortization.
- Changes in working capital, or the difference between the business’s current assets and current liabilities.
Note that operating cash flow doesn’t include cash flows from investing or financing activities. For example, it doesn’t account for cash spent on paying off debt or buying new equipment.
Operating Cash Flow vs. Net Income
Operating cash flow is the cash a business generates from its normal business operations. This is a measure of the business’s ability to generate cash. Net income, on the other hand, is the profit a business makes after deducting all expenses from its revenue. This is a measure of the business’s profitability.
Operating cash flow only includes cash expenses that involve the actual outflow of cash. Net income includes non-cash expenses like depreciation and amortization. Operating cash flow also accounts for changes in working capital, or current assets and liabilities. Net income doesn’t.
Importance for Ecommerce Businesses
Ecommerce businesses face unique challenges and opportunities. By monitoring and improving operating cash flow, an ecommerce business can improve their overall financial performance and long-term sustainability.
Here are a few areas to consider:
- Efficient inventory management is essential to optimize cash flow because significant inventory costs can impact cash flow.
- Marketing expenses can be substantial and can strain cash flow.
- Customer acquisition costs can be high, and the return on investment can take time. An ecommerce business needs positive operating cash flow to sustain these efforts.
- An ecommerce business needs positive operating cash flow to provide the significant capital investment needed for growth and expansion.
- When an ecommerce business borrows money to finance operations or growth, it needs positive operating cash flow to repay debt and maintain financial stability.
Key Components of Operating Cash Flow
Revenue from Operations
Revenue from operations represents the income a business generates from core business activities. Increasing it by expanding product offerings, improving marketing efforts, or enhancing customer satisfaction, is how you boost operating cash flow.
Cost management is as important as generating revenue. Controlling expenses related to product sourcing, fulfillment, and marketing, can help a business increase operating cash flow. A good pricing strategy can also boost revenue from operations. Balancing competitive pricing to attract customers with healthy profit margins is crucial.
Cost of Goods Sold (COGS)
COGS, being the cost of producing or acquiring the goods a business sells, is a significant expense for ecommerce businesses. It therefore directly impacts operating cash flow.
Inventory cost is a major component of COGS, so effective inventory management is essential in minimizing costs and optimizing cash flow. A few strategies include accurately forecasting demand, optimizing purchasing, and ensuring timely inventory turnover.
If you can negotiate favorable terms with suppliers, you can reduce COGS by a good amount. Try to get discounts for bulk or regular purchases and favorable payment terms. This gives you purchasing power.
If you manufacture your own products, the costs involved, like labor, materials, and overhead, directly contribute to COGS. By optimizing production processes and reducing waste, you can lower your costs.
Operating Expenses
Labor
Labor costs are the direct costs associated with the people who contribute to the company’s operations. They include employee wages and salaries. Note that the costs of excessive overtime can strain cash flow. Benefits like health insurance and retirement plans can add to labor costs.
High employee turnover can mean an increase in recruitment and training costs. This is one great reason to outsource certain positions like ecommerce bookkeeping.
Marketing
Market research can be expensive, and this comes before any hope of profit. Marketing and advertising costs as well as public relations expenses can quickly add up. Another significant cost is sales commissions and other incentives that you pay based on performance.
Logistics
Warehousing and other inventory storage can cost a lot if not optimized. The main logistics expense is transportation for products from suppliers to warehouses to customers. You also need to consider packaging costs for customer orders.
Changes in Working Capital
Working capital is the difference between a business’s current assets and current liabilities. Changes in this working capital can significantly impact operating cash flow.
An increase in working capital, or current assets increasing more than current liabilities, means the business is investing more in operations. This can mean a short-term decrease in operating cash flow because cash is tied up in inventory or accounts receivable.
A decrease in working capital, or current liabilities increasing more than current assets, means the business is collecting cash more efficiently and/or paying bills more slowly. This can mean an increase in short-term operating cash flow.
Examples of factors that can affect changes in working capital include:
- An increase in inventory levels can lead to an increase in working capital.
- A decrease in how quickly customers pay their bills will increase accounts receivable, leading to a decrease in working capital.
- More extensions of supplier payment terms will increase accounts payable, leading to an increase in working capital.
Calculating Operating Cash Flow: A Step-by-Step Guide
Cash Flow Formula for Ecommerce
Cash Flow = Net Income + Non-Cash Expenses – Changes in Working Capital
Or, in more detail:
Cash Flow from Operations = Net Income + Depreciation + Amortization – Increase in Accounts Receivable + Increase in Inventory – Increase in Prepaid Expenses + Decrease in Accounts Payable + Decrease in Accrued Expenses
Step-by-Step Calculation Example
Let’s look at an example of ecommerce operating cash flow using the following sample financial data for a hypothetical quarter:
- Net Income: $50,000
- Depreciation: $10,000
- Amortization: $5,000
- Increase in Accounts Receivable: $20,000
- Increase in Inventory: $15,000
- Increase in Prepaid Expenses: $3,000
- Decrease in Accounts Payable: $8,000
- Decrease in Accrued Expenses: $2,000
Cash Flow from Operations = $50,000 + $10,000 + $5,000 – $20,000 + $15,000 – $3,000 + $8,000 + $2,000
= $47,000
The positive cash flow amount shows that the business generated more cash from its operations than it used during the quarter in question.
The increases in accounts receivable, inventory, and prepaid expenses, had a negative impact on cash flow while the decreases in accounts payable and accrued expenses had a positive impact.
Note that in a real-world scenario, you need to consider other factors in your computation, like cash flows from investing and financing activities.
How to Use Financial Statements to Track Cash Flow
Understanding how financial statements are interrelated can help you effectively track your business’s cash flow to make informed financial decisions. For example, you should know how to read your income statement, balance sheet, and cash flow statement.
Start by focusing on a specific period on your financial statements. For example, you can choose to analyze your statements on a quarterly basis. This helps you to identify changes and track trends over time. Then, compare your current financial statements to industry benchmarks.
Calculate cash flow ratios like the current ratio and quick ratio to assess liquidity and short-term cash flow. Use your latest financial statements to create cash flow forecasts and anticipate future cash needs.
Understanding Cash Flow Statements for Ecommerce
What is a Cash Flow Statement?
A cash flow statement is the financial report that shows your business’s cash inflows and outflows over a specific period. It gives you a detailed picture of how the business generates and spends cash, its financial health, and liquidity.
A cash flow statement has three main sections. Operating Activities presents cash flows related to day-to-day operations. Investing Activities shows cash flows related to investments in assets like property and equipment. Financing Activities details cash flows related to financing activities like issuing stocks and dividends, and borrowing money.
Reading a Cash Flow Statement
Positive overall cash flow indicates that your business is generating more cash than it is spending. Negative cash flow can indicate financial difficulties. You need to look at the changes in cash flow over time to spot important trends and potential issues.
To assess liquidity, you need to calculate cash flow ratios like the current ratio and quick ratio. You can also use cash flow statements to create forecasts and anticipate future cash needs.
Strategies to Improve Operating Cash Flow for Ecommerce Businesses
1. Optimize Inventory Management
Use resources like historical data, market trends, customer analytics, and inventory forecasting tools. This helps you to accurately forecast demand for your products so you can avoid both overstocking and stockouts.
Do regular inventory counts to keep records updated and fix discrepancies. Order products only as needed to reduce storage costs and minimize the risk of obsolescence. This frees up cash for other purposes, too.
Prioritize high-value items and Allow suppliers to manage inventory levels where it makes sense. Implement strategies to move obsolete items.
2. Tighten Control Over Accounts Receivable
Give customers clear credit payment terms upfront. Conduct credit checks for large purchases or set up credit limits to manage risk and prevent excessive credit extensions.
Automate invoicing to ensure accurate and timely invoices and encourage prompt payment. Electronic invoicing and offering multiple payment options speeds up the payment process further.
Track outstanding invoices, identify problem accounts, and incentivize early payments where it makes sense. Send friendly payment reminders and follow up with customers who haven’t paid their invoices on time.
3. Extend Accounts Payable Terms
Build strong relationships with suppliers before you negotiate longer payment terms, which delays cash outflows. Make sure you balance the payment cycle with cash inflows. Take advantage of cost-effective early payment discounts to reduce costs.
Implement a centralized system to manage vendor payments to prevent errors. Electronic payments are faster and can reduce administrative costs.
Consider withholding payments from suppliers with performance issues or late deliveries until problems are resolved.
4. Reduce Operating Expenses
Automate repetitive tasks using available tools, like inventory management, customer relationship management, and ecommerce accounting software.
Outsource non-core activities like customer service or fulfillment. Make sure you evaluate the benefits before choosing an outsourcing partner. Invest in training and development and implement performance management systems where it makes sense to improve productivity.
Use lean marketing strategies. Launch a minimum viable product to test market demand and gather feedback. Implement A/B testing and tailor your marketing efforts to customer needs and pain points. Build an email list and focus on creating high-quality content for them.
5. Enhance Sales and Revenue
Focus on high-margin products to generate a significant profit margin. Make sure your prices are competitive, considering the value your products or services provide to customers.
Take advantage of upsell and cross-sell strategies to increase your average order value. Use data analytics to recommend products to individual customers.
Implement customer loyalty programs that reward repeat customers and large orders with discounts, exclusive offers, or points. Use these to encourage repeat purchases and increase customer lifetime value.
6. Leverage Financing Options
Consider getting a fixed-term loan with regular payments or lines of credit to access funds as needed. Small Business Administration (SBA) loans are government-backed and have favorable terms.
Alternatively, merchant cash advances give you quick access to funds in the form of a lump sum in exchange for a portion of future credit card sales. This comes with high interest rates, though. You can also sell your accounts receivable, called factoring, to immediately convert outstanding invoices to cash.
Other financing options include crowdfunding, selling a portion of your business to investors, borrowing against your inventory, and leasing or financing finance equipment to avoid upfront costs.
Frequently Asked Questions
How can I forecast cash flow for a new ecommerce business with no history?
Analyze industry averages for similar businesses and adjust based on your business’s specifics. Conduct market research to estimate potential sales volume, revenue, and expenses. Estimate the inventory you’ll need, too.
What should I do if my ecommerce business has inconsistent cash flow due to seasonal demand?
Consider balancing things by selling products that are in demand throughout the year. Offer incentives on seasonal products during off-peak seasons and encourage pre-orders or subscriptions.
Can automating my accounts payable system help improve operating cash flow?
Automation can streamline the payment process to get discounts and avoid late fees. It also helps minimize errors like duplicate payments and frees up people to work on other important tasks.
How does offering multiple payment options to customers affect operating cash flow?
Offering multiple payment options can make you appealing to a wider range of customers. More convenient payment options can enhance the customer experience and result in faster payment processing.
Should I prioritize increasing revenue or cutting expenses to improve my operating cash flow?
Increasing revenue can increase cash flow significantly, but might require additional investment in marketing, sales, or product development. Cutting expenses can quickly reduce costs and improve cash flow, but might limit your growth potential. It can also negatively impact the customer experience.
What Is EcomBalance?
EcomBalance is a monthly bookkeeping service specialized for eCommerce companies selling on Amazon, Shopify, Ebay, Etsy, WooCommerce, & other eCommerce channels.
We take monthly bookkeeping off your plate and deliver you your financial statements by the 15th or 20th of each month.
You’ll have your Profit and Loss Statement, Balance Sheet, and Cash Flow Statement ready for analysis each month so you and your business partners can make better business decisions.
Interested in learning more? Schedule a call with our CEO, Nathan Hirsch.
And here’s some free resources:
- Monthly Finance Meeting Agenda
- 9 Steps to Master Your Ecommerce Bookkeeping Checklist
- The Ultimate Guide on Finding an Ecommerce Virtual Bookkeeping Service
- What Is a Profit and Loss Statement?
- How to Read & Interpret a Cash Flow Statement
- How to Read a Balance Sheet & Truly Understand It
Conclusion
Implementing these and other strategies for improving operating cash flow can make a huge difference in your ecommerce business. They can help you optimize how you spend to generate more revenue in the future without putting your financial health at risk.
