For every business, cash flow is a very important factor on how successful your business will become, how far you can grow and how fast you can get there. If you run out of cash, it’s game over.
While there are so many aspects to cash flow for an eCommerce business, there’s one I wish to focus on today and that’s the cash flow generated by buying and selling your inventory because for most eCommerce businesses, inventory is their #1 biggest asset on the books as well as the biggest user of cash.
Allocating your cash for inventory inaccurately can crush your business as well as allocating your cash for inventory effectively can provide you a tremendous competitive advantage. Let me explain.
Many many years ago while I was getting my APICS CPIM Certification I learned an important lesson about what’s called your inventory “Cycle Time” and how important your cycle time is on your business cash flow. Sometimes you’ll hear the term inventory turnover as well.
In simple terms, you should look at the cycle time as the time it takes from when you buy the inventory (when the cash leaves your hands) until when the item sells and the cash is back into your hands.
Here’s a typical case for me on a fast selling item
Day 0 – I pay for the product with wire transfer out of my bank
Day 4 – I receive the product
Day 6 – The item sells and ships
Day 7 – My money is back into my bank account
In this simple scenario the cycle time for my money is 7 days.
The very basic way to calculate your cycle time is to take your inventory cost of goods over a period of time divided by your average inventory over this same time. That equals your inventory turnover. I like to look at it from a “Number of days” standpoint so I then divide the total number of days in the period you are calculating by the turnover number. For example if I calculate this number for my eCommerce business for the entire year of 2013 my turnover rate was 34.8 meaning my inventory turns 34.8 times per year. It’s hard for me to relate this number to make good business decisions so I then take 365 days divided by the 34.8 to find out my inventory turns over every 10.5 days. Now that makes more sense to me and most likely makes more sense to you.
I think I first heard the term by “Mr Wonderful” on Shark Tank that he likes to send his little soldiers out to battle and have them come back with more little soldiers. Of course referring to his money. I love this analogy and use it myself. I look at my money as little soldiers and I want to send them to battle and bring back more little solders for me to use in the future. I want them to do this as quickly as possible AND I want them to bring back as many additional soldiers as they can.
Tip: It’s very important to watch BOTH your profit margin AND your cycle time to get the true picture.
When I hear sellers say they made $50 profit on their item, that doesn’t tell me much. I also want to know how much it cost them and how quickly they did it. If they took 3 months from the time of purchase to the time of the sale that is far less impressive to me than if it took them 3 days.
Let me give you two scenarios to better demonstrate why it’s important to watch both profit margin AND cycle time.
Scenario 1: The item costs $100 and sells for $150 for a $50 profit and takes 4 weeks to sell from the time of purchase.
This is not a bad scenario. I bet many sellers would be happy with this. Most would say that making a 50% ROI per month is much better than you will make betting on the stock market most of the time. Honestly, turning your inventory over every month or 12 times per a year is already faster than most industry averages. You can pat yourself on the back if you are currently running at this level.
Scenario 2: The item costs $100 and sells for $150 for the same $50 profit and it takes 1 week to sell from the time of purchase.
In this scenario the seller made the same 50% ROI but they did it much faster. The key is what happens next. Next the seller uses this same $150 to buy more inventory, sending their soldiers back out to battle and 1 week later they come back with another $150 and now you have $200 to spend on product. You spend the $200 instead of $100 this time so you buy 2 of these units during week 3. These 2 units then sell in 1 week for a total of $300 and you buy 3 units during week 4 and they all sell for $450 during the 4th week.
RESULTS: In scenario 1 you’re a happy seller making a $50 profit for a 50% ROI. However, would you be even happier if your same $100 investment made you $350 ($450-$100) profit during this same 4 weeks? Of course you would!
While increasing your inventory cycle time by 4x, due to compounding profits you actually increased your net profit by 7x! Stop and think about that for a minute. Take 2 minutes if you need…
For training purposes, I ran this scenario for only 1 month, consider the level of compounding growth in profits if you did this for the entire year…or even for many years!
Please note, in both of my scenarios we have to make some assumptions. One big assumption is that supply and demand are not constrained. Assuming if you have the product it will sell. Supply and demand constraint are topics for another blog post but let’s assume these are not constraints in this example for sake of understanding the impact of inventory cycle on profits and cash flow.
It’s true, at some point your product and price offer will saturate the demand where adding more supply won’t increase the demand or your sales. At this point you need to shift your focus to increasing demand by increasing traffic, exposure and awareness, or find other inventory items to invest your money into. While my scenarios were kept simple to help you quickly understand this very important principle, it’s really about the dollars and not the product so this same compounding profit principle holds true for whatever inventory you buy and across multiple items as well.
The important thing to remember is that you’re sending your soldiers (dollars) out to battle and they need to return to you as quickly as they can bringing you as many new soldiers as they can.
If you would like my help coaching your eCommerce business to increase your inventory cycle time ultimately increasing your cash flow and profits, give me a shout!
Cheers to selling smarter!
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