How Ecommerce Companies Can Optimize Cash Flow Management

Cash flow represents the financial bloodline of a business. Just by looking at the positive or negative cash flow values, you can gauge a company's financial health. Yet, it is hardly ever the first thing on the mind of an ecommerce business because most companies have difficulty tracking and managing their cash flows. It is one of the most significant contributors to the failure of business ventures, especially in the small business category.

22% of businesses fail within their first year, and the probability of failure keeps growing as the company approaches a decade in age. Financial challenges are responsible for the failure of 66% of such businesses. You need efficient cash flow management to keep your business running and to escape being part of the failed business statistics.

This is all the more important for an ecommerce business owing to the dynamic nature of the industry. The market trends in ecommerce can shift dramatically. These trends can affect both the supply and demand side of the business. Consequently, these fluctuations will impact your cash flow.

In this article, we will look in-depth at cash flows for ecommerce businesses. We will also cover ways to optimize the cash flows and common financial management mistakes that ecommerce businesses should avoid. By the end of this guide, you should be able to track, understand, and manage the cash flow of your business.

What is Cash Flow Management?

Cash Flow management is all about controlling the money coming and going out of your business account in a period. The name itself says it all. Cash refers to money, and flow refers to the movement of money through your ecommerce business.

You are basically tracking and managing your business's income and expenses. However, in cash flow management, you focus more on the circulation of finances through the businesses rather than in silos. Still, for better understanding, let's look at these aspects individually:

What are Income and Expenses in Cash Flow Management?

Income: This is the cash flowing into your business. In ecommerce, you can generate income in several ways. These include product sales, subscriptions, advertisement revenue, affiliate programs, and so on. Regardless of the source, if you are receiving money, it counts as income or cash inflow. 

Expenses: This is the money that flows out of your business account. Ecommerce companies may incur different types of expenses for running their business. These include supplier payments, warehouse rent, marketing costs, shipping charges, etc. Whether you are paying a subscription fee for an email marketing tool or using international courier services for order fulfillment, if the money leaves your bank account, it is an expense or cash outflow.

Understanding Positive and Negative Cash Flows

You need to track both these movements of money for cash flow management. You will track both of these in a given period and compare their values for cash flow management. You can use the below formula to track the net cash flow of your ecommerce company. Consequently, it tells you whether your company is profiting or in debt for a given period.

🔎 Net Cashflow = Total Cash Inflows - Total Cash Outflows

If you have more money coming in (income) than going out (expenses), then your ecommerce business is in positive cash flow. 

🔎 Income > Expense = Positive Cash Flow

However, if you have more money going out than coming in, then your company is in negative cash flow. 

🔎 Expense > Income = Negative Cash Flow

Positive cash flow shows that you are making more money than you are spending. In contrast, negative cash flow indicates that your company is spending more money than it is earning.

For example, let's say your ecommerce earned $500 and spent $340 in 2023. So, your net cash flow will be $160 ($500 - $340). However, if the values are reversed, your net cash flow will be -$160 ($340 - $500).

The first scenario shows positive cash flow, and the second shows negative cash flow. In the first scenario, your company earned a profit of $160 in 2023. While in the second scenario, your company is $160 in debt for the year 2023.

Tracking cash flow allows you to monitor the financial condition of your ecommerce business in a given time period. It is a bird-eye view that helps you recognize areas for improvement.

Different Types of Cash Flow

The cash flows are categorized based on the source of revenue and expenses. Segregating the cash flows into these categories helps you understand how the money flowing through your company depends on different activities. Let’s understand the different types of cash flows in further detail with some examples for ecommerce.

1. Cash Flows from Operations (CFO)

CFO focuses on the income and expenses concerning ecommerce operations. It is also known as operating cash flow. It indicates the flow of money through the production and sale of products.

🔎 CFO = Net Revenue from Sales - Operating Expenses

Here you only account for income generated from product sales as cash inflow. You cannot include the entire revenue of your ecommerce business to calculate CFO. Similarly, you only consider expenses paid for operations as cash outflow.

Operating cash flow tells you whether your ecommerce company can remain in business solely based on product sales. Let’s say you sold products worth $8000 in August 2023. During this period you spent $4500 on operations. In this case, your CFO is $3500. The positive value indicates that your company generated a profit in August.

However, if you earn $1000 dollars from ecommerce sales in September 2023. But, you are still spending $4500 on operating expenses, then your CFO is - $3500. If you combine the cash flow for August and September, your CFO is $0. You have spent all the cash that you earned through sales.

This means that you do not have the cash to pay for the operations of October. Furthermore, if the operational expenses are to remain the same, you will need to earn $9000 through sales to pay off the debt of October and continue the operations in November.

2. Cash Flows from Investing (CFI)

CFI reports the amount of cash generated through a company’s investments in a given period. This includes income and expenses related to assets, securities, mergers, acquisitions, and so on.

🔎 CFI = Revenue Generated from Investments - Capital Expenditures

For CFI, you only account for cash earned or spent from investment-related activities. It does not include sales revenue. An ecommerce business may invest in several types of assets. These include websites, blogs, ad spaces, social media accounts, databases, digital infrastructure, and so on. 

For instance, you purchased a Blog Website to expand your reach. This is an asset for your ecommerce business. You use the traffic on the website to promote products and generate sales. At the same time, you also lend ad space on the website to other businesses and collect revenue from clicks and impressions. 

The amount paid for the purchase will count as a cash outflow for CFI. The revenue generated from ad space will be part of your cash inflow for CFI. But, the revenue generated from sales through the website will count as cash inflow for the CFO. However, when you sell the website, it will count as cash inflow for CFI.

3. Cash Flows from Financing (CFF) 

CFI is a report of the flow of money concerned with the financial activities of a company. It includes capital, debt, equity, loans, and dividends. It represents the flow of cash between the company and its stakeholders such as shareholders, owners, creditors, and investors.

🔎 CFF = Revenue from Issuing Debt / Equity - (Paid Dividends + Repurchased Debt / Equity)

You only have to account for the movement of capital when calculating CFF. This cash flow gives you insight into the company’s capital structure and financial strength. Let’s understand this better with an example:

An investor purchases 10% of your ecommerce company’s share for $100,000 in Q1 of 2023. In the same period, you issue $20,000 in dividends to existing shareholders. You also used the cash inflow to pay off a loan of $12,000 to a bank. In this scenario, your CFF for Q1 of 2023 is $68,000 (100,000 - 20,000 - 12,000).

4. Free Cash Flow (FCF)

Free cash represents the money left with a company after deducting all obligations for a period. It shows the true capacity of the company to generate cash. You also need this value to plan future expenses for your ecommerce business.

🔎 FCF = Operating Cash Flow - Capital Expenditure

FCF is also a representation of your company’s net income. This is the money you are left with in your reserves for expenses, investments, debt payments, etc. It’s basically the money on hand.

For instance, your CFO is $80,000 for 2022 and you have spent $30,000 in capital expenditures. Then you have $50,000 of free cash flow for 2023. It means that after making all the investments and paying all the expenses for 2022, you are left with $50,000 to use in 2023.

Why is Cash Flow Management Important for Ecommerce?

Cash flow management gives you a clearer picture of your company's finances. Merely accounting for profits and losses can be misleading. While profits only represent the money owed to your company, cash inflow shows you how much money has actually been received.

For instance, your ecommerce website shows a $99 profit from Google Adsense revenue. But, you will not be able to use this money as the cap for payout in Adsense is $100. The $99 counts as profit but not as cash inflow.

Cash flow management gives you a clear idea of the money moving in and out of your company's bank account. It is the money you have on hand and the money you actually spend. This information is necessary for making financial, investment, and operational decisions.

Positive cash flows indicate that you have a profitable business that can remain operational without financial aid. These factors play a crucial role in attracting investors and receiving loans.

Best Practices for Cash Flow Management

Here are a few best practices that you should use for implementing a cash flow management system:

• Define a period for cash flow analysis and create regular reports
• Segregate cash flows by type for better insights
• Integrate all payment processors with one accounting system
• Use payment processing software to streamline multi-currency transactions
• Schedule expenses based on net cashflows instead of cash inflows or profits
• Use sales and expense forecasts to generate a cash flow forecast
• Use insights from cash flow forecasts for ecommerce business planning

Without effective cash flow management, you will not be able to make informed decisions concerning inventory purchases, investments, reserve capital, marketing spending, business expansion, and so on. You also risk running out of cash, which is the reason why 29% of small businesses fail.

How Ecommerce Companies Can Optimize Cashflow Management

It is not enough to gain insights from cash flow statements. For the healthy financial operation of your ecommerce business, you also need to optimize the cash flow. Here are five ways to do that:

1. Implement a Cashflow Management System

You need a streamlined system to manage, monitor, and analyze your cash flows. You can use accounting software to generate cash flow statements. Several ecommerce platforms also provide tools, such as Shopify Cash Flow Calculator, to help you manage cash flows. You can also use Google Spreadsheet Templates to feed cash flow data and generate reports manually.

Source: Cash Flow Projection Template

2. Monitor your Cash Flow System Regularly

Cash Flows are measured for a particular period. You need to define a periodic schedule for monitoring your cash flow. This can be monthly, quarterly, bi-annually, or annually. With each review, you should gather reports on the CFO, CFI, CFF, FCF, and net cash flow. You should also use this opportunity to generate cash flow forecasts for the next period to help you plan your ecommerce finances.

💡Tip: You can integrate your Xero account with a Statrys business account so you can monitor your cash flow regularly.

3. Manage your Accounts Receivable

Pending accounts receivable hinder positive cash flow in your ecommerce business. Accounts receivable is the amount owed to your company. You can increase cash inflow by pushing the customers, clients, or buyers to complete transactions. If needed, you should facilitate them with easy payment options to expedite cash inflow.

4. Control your Inventory

According to the Digital Commerce Spend Report, ecommerce businesses spend 18.22% of their budget on inventory. This is a significant cash outflow. You can turn the tide in favor of positive cash flow if you adopt lean stock management strategies such as available-to-promise inventory or just-in-time delivery. This will help you control the flow of inventory and reduce the risk of overstocking and stock damage.

5. Negotiate Payment Terms with Suppliers

You can improve cash flow management by negotiating better terms with your suppliers and vendors. Here, better means more favorable for your cash flow. The supplier payments should align with your period of positive cash flow. Alternatively, you can negotiate contracts for bulk supply and define payment terms based on built-up free cash.

Common Cashflow Management Mistakes to Avoid in Ecommerce

Here are some common mistakes made by ecommerce companies that can hinder cash flows:

1. Poor Inventory Management

Problems with inventory management can lead to unnecessary cash outflows. Purchasing too much inventory can lock up your cash in stock. Then your ecommerce financial health is completely dependent on sales. 

It also takes away additional cash in the form of warehousing and maintenance expenses. You also risk incurring losses from stock damage or products going out of trend. This is especially risky in the case of fashion ecommerce.

2. Lack of Cash Flow Forecasting

You only have limited information to work with if you are not forecasting cash flows. While cash flow statements are important, they only show you the present situation. At best, you can use this data to plan expenditures for a short period. This may lead to unnecessary expenditures or cost-cutting. On the other hand, cash flow forecasting gives you long-term visibility for informing your business decisions. 

3. Inadequate Payment Processing

Payment processing is the gateway to an ecommerce business's primary source of revenue. If this system is flawed, it can drastically affect the cash flows. You might expect to see sales revenue in your account only to find it held up because of a technical error. You need a reliable payment processing system that can manage the volume of sales and facilitate your customers with adequate payment options to avoid cart abandonment.

4. Reliance on Sales Revenue 

If your cash flow only relies on sales revenue, the entire company depends on positive cash flow from this source. Ecommerce sales are subject to a variety of trends and geo-political situations. Many of these may not be under your control. Hence, you need to create alternate sources of cash revenue to stabilize your business's cash flow. You can develop alternate ecommerce cash inflow sources such as lending ad spaces, content subscriptions, affiliate marketing, etc. 

Final Thoughts

It is necessary for ecommerce businesses to harness the insights from cash flow management from the get-go. It helps you assess the actual financial status of your company. You plan your investments and expenses based on the cash flow statements and forecasts.

This would play a crucial role in the growth of your business. It will also serve as the foundation for building your ecommerce business's portfolio to invite investors to grow your brand. When you expand internationally and deal with customers from different countries, you should consider using a virtual business account to manage all major currencies with a single system.