When running an ecommerce store, cash flow forecasting is one of the most important things you can do.
Well, it helps prevent you from running out of money!
It may seem obvious: your ecommerce store needs money to keep operating. But if it’s so apparent, why do 32 % of ecommerce businesses fail due to running out of cash?
The answer is that it’s not always obvious you’re running out of money. For example, it’s possible to make a good profit one month but still be on the path to depleted cash reserves in the near future.
To understand this, you need to understand cash flow.
What is Cash Flow?
Cash flow is the amount of money flowing in and out of your business. It’s related to, but not the same as, profit or your balance sheet. Profit shows how much money is left over after expenses – your company’s net gain for a given period. A balance sheet shows all liabilities and assets, including things like accounts receivables and buildings you own.
In contrast, cash flow is not interested in assets like accounts receivables or buildings – it’s only concerned with the amount of money your business has on hand right now. In other words, cash flow only looks at liquid assets – assets that can be converted into useable money as quickly as possible.
So, cash flow forecasting makes an educated guess as to how much money (liquidity) you’ll have on hand at a specific point in the future. In this way, it lets you know whether you’ll have enough money to make that loan payment in a few months or afford payroll next week.
Similar to a weather forecast, a cash flow forecast gives you the data you need to decide on the best time to take a certain action. Just as you wouldn’t go hiking in a storm, it’s not a good idea to launch a Black Friday marketing campaign when you’ll need that money to pay creditors.
By showing you how to optimally manage your money, cash flow forecasting helps ensure your ecommerce business will be in a good place a few months or years down the line.
How to Calculate Your Operating Cash Flow
There are a few different types of cash flow forecasts.
The most basic, and the type we’re concerned with here, is operating cash flow (OCF). Just as it sounds, an operating cash flow forecast reflects normal operations: the cost of running your business and the revenue generated by selling products.
To calculate OCF, first, choose the length of time you want to evaluate. For ecommerce, a shorter time frame is better because it will give you a more focused picture, with fewer variables.
The formula to calculate your current operating cash flow can be relatively simple:
Operating Cash Flow (OCF) = Net income + Non-cash expenses – Increase in working capital
Get these numbers from your records and plug them in.
Once you have your result, your natural next question will be:
How Do I Know if My Operating Cash Flow is Good Or Bad?
The answer is with an operating cash flow ratio.
The formula here is also simple:
Operating Cash Flow Ratio (OCR) = OCF/Current Liabilities (CL)
For OCF, take your result from the last equation.
CL is current liabilities. Here, include anything that needs to be paid within the next year.
A healthy operating cash flow ratio is at least 1. If the result is below 1, you’re going to run out of money – you need to make adjustments or your business will fail. If the result is at or above 1, though, it means you have enough money to keep operations going.
More than that, however, a result above 1 shows how much wiggle room you have. The higher above 1 the number is, the more extra cash flow you have to invest in expanding your business.
If it’s at 1.04, for instance, you probably can’t afford much expansion. But if it’s at 1.35, you have a bunch of extra capital sitting around that you should use to scale! Remember, though: you need to make sure any hypothetical new expenses are sustainable. Add those numbers in, and perform another calculation.
If the result is suddenly below 1, it means you need to boost revenue before you make that investment in your business.
Fortunately, there are plenty of ways to strengthen your ecommerce cash flow strategy.
How to Boost Ecommerce Cash Flow
Do Proper Bookkeeping
Proper, meticulous bookkeeping will be the foundation of your cash flow forecast. Record every transaction, from purchases and sales to payrolls. Ensure the information is as accurate as possible.
Get Paid As Quickly As Possible
Some ecommerce sellers like to incentivize sales by offering longer payment terms. However, this automatically has a negative effect on cash flow. You want that money as soon as possible so you can use it.
Getting payments upfront is always the best option. However, we understand you may want to attract customers by offering several payment methods. That being said, only opt for something like 30- or 90-day payment cycles if you have significant cash reserves.
Buy now, pay later is another option. This method has become increasingly popular online – since you get paid immediately, but the customer can pay over time, it offers the best of both worlds.
It’s a given that you should be using services like PayPal or Stripe so that customers can make transactions immediately. Obviously, the more payment options you can offer, the more likely your customers will find one that works for them and the more likely you’ll get paid.
With that said, make sure you understand the payment terms from your payment providers. Especially for new ecommerce businesses, there can sometimes be holding periods where you’re not able to withdraw your balance, even if the customer has paid (we’re looking at you PayPal).
If you’re selling in countries like India that use payment on delivery, consider providing incentives for earlier payments like discounts, for example.
Delay Your Payments
Talk to your creditors and suppliers. See if you can defer payment to a later date, or at least pay only part of what you owe. Overall, there’s a two-pronged approach here: shorten the time it takes for you to be paid, and lengthen the amount of time before you have to pay.
This boosts your cash flow by ensuring you have more money on hand at any one time.
Line Up Expenses With Revenue
To pay your expenses, you’re going to need cash on hand. This highlights another drawback of long payment cycles – your revenue may lag behind your expenses.
If you know sales take off at a certain time of the month, try to set your own payments to that time. Also, make sure invoice due dates line up with those dates.
If you recently launched your ecommerce business, you may still be getting a sense of when customer payments tend to come in. Once you get a clearer picture, see if you can renegotiate your due dates to line up more closely.
Rethink Your Marketing Strategy
Are you advertising somewhere on the Internet but not seeing a good return on investment? Now may be the time to cut that campaign and try a different one. Consider why the old channel didn’t work when choosing a new one. Maybe it was the wrong demographic, or there were too many competitors with the ability to outspend you.
Incidentally, remember that online advertising campaigns don’t always have to be expensive. Sometimes, they can even be free. E-mail marketing, for instance, can help bring in old customers and boost your revenue without the costs of establishing yourself on a new platform.
Tweak Your Website
With ecommerce, your website is your storefront – you want it to be as welcoming and easy to navigate as possible. If you have a high bounce rate, consider factors like page loading time, readability, and whether you have clear calls-to-action.
These days, it’s also critical for websites to be mobile-friendly – around 91% of Americans between ages 18 and 49 use their phones to buy things online. In addition, search engines tend to penalize websites that are not mobile-friendly.
Make sure your site has clear pictures or even videos of your products. This will help reduce return rates by ensuring customers know exactly what they’re getting.
If a specific product’s selling like hotcakes, it can be tempting to buy up a large stock. But, especially in ecommerce, trends aren’t always predictable – if demand suddenly decreases, you’re now holding onto a bunch of useless inventory that’s depleting your cash flow.
Remember: cash flow is all about the money you have now, not money you may potentially earn in the future. Unsold products are of no interest to your cash flow forecast. So, only buy a specific amount of product if you have a pretty certain idea that you can sell it within a set time span.
Get rid of extra products by offering discounts or even attaching them to other orders.
Look At Packaging
Many ecommerce businesses don’t consider packaging – you just want to make the sale and get the product out there, right?
But even small amounts add up – this is especially the case in ecommerce, where margins tend to be tight. So, if you can make that box smaller while still protecting the product, don’t hesitate to do so!
Increase Average Order Value
Boosting average order value (AOV) is helpful for multiple reasons. First, it means you don’t need as many customers to earn the same level of income. You may be able to scale back certain advertising efforts as a result. But even if you don’t want to, those campaigns will be more cost-effective as you have a stronger overall cash position.
Next, raising AOV is a way to increase your cash flow without raising your overhead.
So, how do you boost AOV?
One method is cross-selling. If a customer is about to buy something, you can alert them to a complementary product in the hopes they’ll purchase that, too. Then, there is also upselling, where you offer a product with more features for a slightly higher price.
You might also offer free shipping to customers whose order has crossed a certain price threshold.
Boost Customer Retention
Boosting customer retention will save you money – studies show it’s actually more cost-effective than acquiring new customers. Connect with customers by building a presence on social media sites like Instagram or YouTube. It’s also a good idea to get e-mail addresses, so that you can send special offers even months after their most recent purchase.
There are even several tools using AI in ecommerce that will help you personalize the shopping experience to increase satisfaction and launch smart re-marketing campaigns.
Consider setting up a rewards program: maybe if a customer has ordered a certain amount of product over a few months, you offer them a free one, or a substantial discount.
Similar to boosting AOV, increasing customer retention doesn’t increase your overhead. Also, since it helps make income more regular, your cash forecast will be more accurate.
How Trovata Can Help
You can’t run a business without liquidity and ecommerce cash flow forecasts are the best tool available to ensure you always have it!
Of course, your forecast will only be as useful as it is accurate.
Trovata helps ecommerce companies like Etsy, Square, and Sonos make this happen. Transactions are recorded right as they’re made, ensuring your data is accurate and in real-time. APIs connect this information across accounts, so you don’t have to visit multiple bank portals.
“Square’s teams can do instant analysis across millions of transactions, across all of our banks, and every single account.”– Tim Murphy, Head of Financial Operations & Treasurer, Block (Formerly, Square) on the benefits of using Trovata
Complex machine learning algorithms understand your company’s financial behavior over time, helping to make cash flow forecasts that much more solid.
If cash flow forecasting is the foundation of your business, Trovata is the foundation of your cash flow forecasting. Schedule a demo today!