Cash Conscious: E-Commerce - Part 3

The Intro

Hello, we hope you all had a good holiday weekend! Now we get back to our discussion on the Cash Conversion Cycle (CCC) and how we can improve it. If you need a refresher on the CCC, you can find my article from last week here.

In Part 3 of our e-commerce series, we will dive into the pain points around the days inventory outstanding (DIO) part of the CCC calculation. DIO refers to how many days it will take from when you purchase your inventory to when the customer buys it from you.

DIO is a significant component for e-commerce businesses. Inventory management is critical for profitability and cash flow management. The faster your inventory moves, the less you pay in holding costs, and the quicker you collect cash from sales.

In this article, we will discuss four areas you can make improvements:

1. Supply chain relationships

2. Fulfillment

3. Inventory management systems

4. Sales forecasting

Supply Chain Relationships

You likely already know how vital your suppliers and vendors are to your business. Without them, you do not have a product to sell, so it is imperative to maintain good relationships.

I strongly recommend you perform a relationship analysis before engaging in the suggestions below. We won't cover the analysis here, but it will give you the confidence to know if the following suggestions are a viable discussion to have.

Let's look at supplier/vendor relationships first. They are the first link in your business's supply chain. From a DIO perspective, there does not appear to be an opportunity to shorten it because your inventory is not technically purchased until you take ownership.

While this is factually true from a financial accounting perspective,

it neglects the amount and timing of the deposit your business needs to place to secure your order. The deposit is a cash outflow, so the CCC must consider the deposit.

How would you calculate the days added to the CCC by the deposit? Here is my calculation:

· (Deposit amount / total order cost) * days between deposit payment and inventory ownership

This calculation points to two levers we can discuss with our supplier/vendor:

1. Reduce the amount of deposit required.

2. Increase the payment terms on the deposit (i.e. reduce the payment and inventory ownership gap).

Ok, we have covered suppliers and vendors of your product. I want to briefly touch on transportation services from your supplier/vendor to your facility or fulfillment centre. Don't ignore this leg of your inventory's journey.

For example, I worked with a company that was using two methods of transport - trucking and railroad. The railroad had delays and would show up at unexpected times. Even though it had a lower sticker price than trucking, the delays increased the DIO. The unpredictability also impacted other areas of the CCC, making it a more costly option overall.

Note: notice the word unpredictability above and recall that we want predictability in a healthy CCC! See Part 2 for more detail.

Suppose your supplier/vendor takes care of the shipping; lucky you! If not, make sure you look at this leg for opportunities.

Fulfilment

The next stop in your inventory's journey is your warehouse or third-party logistics (3PL) fulfillment centre. This stop is about organization and capacity to move your inventory on to your customer. It does not directly impact DIO but can indirectly affect it through your sales and not keeping an optimal amount of inventory on hand.

Choosing your fulfilment method:

1. Do you need a warehouse of your own? It has high fixed costs to keep the service level you will need. A warehouse can be advantageous if you are operating on a large scale.

2. Will a 3PL fulfillment centre suit your needs? Fulfillment centres operate on a variable cost per unit you move through them. They are great if you have not reached the scale to justify the fixed costs of owning a warehouse.

It is critical for either option that your inventory remains organized. You know where it is and how much of it you have. An inventory management system will help, but the physical goods still need to be kept in a way that will match this system. Without an organized warehouse or fulfillment centre, you won't benefit from the system.

In addition to being organized, your business needs to maintain its shipping time standards. The warehouse or 3PL fulfillment centre must have the capacity to do this.

The warehouse you have control of, and to an extent, you do with the 3PL fulfillment centre. Look for an alternative centre if your current one is unorganized and causing you delays!

Inventory Management Systems

An inventory management system is where you can make the most significant impact on your DIO. An e-commerce business's ideal state is operating a just-in-time (JIT) inventory system.

What is JIT inventory? It technically refers to raw materials arriving just-in-time for a manufacturing production run. Many e-commerce stores may be ordering finished goods, so this concept does not fit the situation exactly. However, we can use this concept to define an ideal state and work towards bettering the business.

The ideal state: inventory arrives at the facility, is sold, and then shipped within a short period. Let's say one day!

Ok, ok, I know that is an overly optimistic timeline, but my point is that if we strive for this, we will be reducing our DIO and improving our business.

So how do we work towards the ideal state? There are software solutions that will help!

The selection of software is an extensive process. Every business is different, and we want to automate as much data flow as possible. Remember the motto: data flow, not data entry.

A robust inventory management system should:

1. Integrate with your online storefronts (and offline if you have physical storefronts).

2. Be the source of truth for the inventory you have on order, on hand, waiting to be shipped and returns.

3. Calculate the $ value of your inventory and the cost of goods sold to keep the accountants happy.

4. Analytic tools allow you to forecast sales and calculate reorder points from the forecasts.

Some tools I recommend:

· For the small e-commerce store - Shopify has a sound inventory management system built into it. It is excellent for small-scale operations that don't need all the bells and whistles.

· For mid-sized e-commerce - InFlow has a barcode system to help manage the warehouse, has reordering capabilities and syncs with your e-commerce storefronts.

· For the large e-commerce business - Dear has it all. The price tag is the highest for this software, but for e-commerce businesses with demanding needs, Dear will make the data flow.

One thing to note when making an inventory management system selection is that you must plan for the future. What are your goals? If they are to be selling through multiple channels in the next year at scale, set yourself up for success and get the right tool at the beginning of the year.

Sales Forecasting

Finally, we must address that sales forecasting is critical to your inventory management and reducing DIO.

To work toward our ideal state (JIT inventory), you need to know when sales will occur to plan to have enough inventory on hand so you don't stock out. On the other hand, you don't want to be holding excess inventory, which comes at a cost.

Performing quarterly sales forecasting will provide the roadmap for when you will need to make inventory orders. It will also provide insight into when you expect to receive cash from sales and when you need to pay your suppliers/vendors, critical components to the cash flow plan.

Optimizing your DIO and CCC rely on the sales forecast. It can be daunting, but you can make a reasonable forecast by utilizing past sales data. It is best to start as soon as possible with forecasting. You will get better at it with each cycle.

A cycle consists of a forecast and reviewing the variances from actuals at the end of the forecasted period. Don't forget to do the review part! You learn what techniques worked and did not, so you improve for the next period.

In Conclusion

Wow, this topic turned out to be longer than I expected. There are many ways you can improve your DIO by looking at the four areas discussed in this article. We have not covered them all but rather shed light on the issues and some tools you can use to start the improvement process.

You likely noticed that each of the four areas intertwined with the other. The improvement process is not simple, and strictly focusing on one likely won't be enough to impact DIO significantly. Be aware of how they intertwine and follow those interconnections. As you do this, you will see other opportunities for improvement not discussed in this article.

About the Author

Nick is a cash management specialist in the e-commerce industry. He helps business owners eliminate uncertainty by developing efficient cash flow management systems. Contact him at 250-885-3088 or nick@razorcon.co to reduce your cash stress.