Cash Conscious: E-Commerce - Part 4
Updated: Jan 22
Last time on Cash Conscious, we looked at the first component of the cash conversion cycle (CCC), days inventory outstanding (DIO). Missed this article, or do you need a refresher? Find it here.
Today we will continue the CCC journey and discuss the days sales outstanding (DSO) component. We will also introduce two new pain points refunds and chargebacks.
Refunds do affect the CCC, while chargebacks do not. These two topics tie nicely with sales, so we will give them some love regardless of their fit with DSO and the CCC.
Days Sales Outstanding - Online Storefront Sales Only
The DSO is relatively straightforward for e-commerce businesses selling only from online storefronts. When a sale occurs, these businesses will take payment from the customer through an online payment processor. This payment collection happens at the time of sale and removes the risk of not collecting payment after you have shipped your product.
The payment processor will have a service level stated on when they will payout the sale proceeds less transaction fees to the business's bank account. Typically the payout timing is 2-3 days.
Pro tip: make sure you set the payout time to the shortest available by your payment processor. The reconciliation process is a breeze when you use integrations with your accounting software, so you don't need to consider batching for efficiency. It is best to have the cash in your account ASAP.
Days Sales Outstanding - with Credit Sales
Not every business is purely through online storefronts, which could add credit sales to the mix. Credit sales are when your business issues an invoice to a customer for a sale made today, but payment will be due at a time in the future. Your customer is technically borrowing the sale proceeds until they are due to be paid.
Credit sales directly affect the DSO. Your business will collect cash after the sale. The longer the due date is from the sale date, the worse off your DSO. There is also the risk that your customer will not pay on the invoice due date, which will further increase your DSO.
Note: you must ensure your inventory management system stays in sync when offering online storefront and credit sales. Not all software does this effortlessly. Syncing inventory levels across each sales channel ensures you don't oversell and your reorder point is visible.
Improving Days Sales Outstanding
We have identified two types of sales proceed collection for e-commerce businesses.
Sellers with online storefronts only have minimal levers to address the DSO directly. They can ensure their payout frequency is the highest their provider offers and look for a new provider with a better frequency if other factors don't impede.
The other factors around the sales process they can address are:
1. Returns, and
These areas do not directly relate to the DSO, but this is an excellent article to bring them into our discussion since they tie in with sales.
We will address returns and chargebacks in greater detail below since they pertain to an online storefront and mixed-channel e-commerce businesses.
For credit sales, there are two opportunities to reduce the DSO:
1. Reducing payment terms, and
2. Managing your accounts receivable.
Reducing your payment terms is self-explanatory. You extend credit for a shorter period, reducing your DSO since you collect on your invoice faster (in theory).
It is good to periodically review your payment terms and analyze if your customers would continue to purchase at a beneficial volume with reduced payment terms.
I see many businesses move on from a sale after sending an invoice. It is a mistake! The sale is not over until the cash is in your account. Don't move on until the cash is received.
A high accounts receivable balance is not a good thing. It means you have extended free credit to your customers! While it may be a cost of doing business, you should still scrutinize your receivables for opportunities.
You will positively impact your DSO if you collect receivables early. Sometimes you need to add incentives like a percentage discount to collect earlier. You must analyze further to determine if this is in your best interest.
Other times a conversation with your large customers can go a long way to speeding up payment. These conversations could lead to reduced payment terms as well.
Finally, it is best to stay on top of your overdue accounts. Overdue accounts hurt your DSO and can severely impact cash flow management. Send reminders when invoices are due and continue to follow up with those delinquent accounts. Your business has done its job, and it is time for your customer to pay up!
Unfortunately, not everyone will be happy with your product. There always will be some level of returns made. Returns affect the CCC. Reversing a sale means less cash to collect. It also means your product is now inventory again.
Back into inventory sounds like an impact on your DIO?
You got it!
Returns extend the DIO. I know we are talking DSO today, and it is best to talk returns when we talk sales.
Returns are not necessarily a bad thing. It is a part of doing business. I would argue that a reasonable level of returns could be a good sign that your marketing efforts are pushing boundaries and reaching new audiences. Note the word reasonable - we still want to limit the return amount. A high number of returns is likely a bad sign.
So how do we factor in returns to our CCC? Understanding your average return rate is critical. Once you have a handle on the average rate, the next step is to work toward consistency.
Remember, a healthy CCC is predictable. Significant swings from period to period in returns make predicting CCC very difficult!
Once you have a handle on a predictable return rate, you can reduce your sales in the period by that rate and add the cost of goods sold back into inventory. This adjustment is essential to understanding your CCC and cash flow planning. When your business grows, you will have more cash coming in today, but you need to prepare for the increase in the following returns and refunds.
The dreaded chargebacks... These hurt your business in a few ways:
1. Cash: loss of cash inflow from the sale.
2. Profit: loss of inventory cost and profit from the sale.
3. Cash and profit: fee charged by the payment processor for the chargeback.
4. Business continuity: too many chargebacks could result in the payment processor locking your account.
A chargeback occurs when a customer purchases your item with an online payment method (e.g. credit card) and disputes the charge. Your payment processor will then charge back the sale proceeds to your business plus a fee. With credit cards, the customer is always right.
A chargeback may occur due to fraud where a stolen credit card number made the purchase. It could also be a customer acting in bad faith.
Sometimes, you may not have shipped the product yet, limiting your losses. However, you are more likely to have shipped the product since the customer will not file a dispute until they review their credit card transactions.
It is doubtful that you will be able to avoid chargebacks altogether. However, unlike returns, there is no silver lining to chargebacks. They cost your business and do not provide you with insights.
Chargebacks do not directly impact your DSO calculation and CCC since they are a pure cash outflow. It is an expense since there is less cash in your account with no future way of recovering it by converting it to a sale.
Understanding chargebacks is imperative to cash flow planning, even though they do not impact the CCC. You need to know what chargebacks cost you and then plan for future cash impacts caused by chargebacks.
Like returns, you will need to determine an average chargeback rate and want it to be predictable! Cash flow planning works better with predictability, just as the CCC does.
We won't explore the tools for minimizing chargebacks in great detail in this article. For now, here are a couple of things to check if your payment provider is doing:
1. Address Verification Check (AVS) - ensuring the billing postal code matches the credit card holder's address.
2. Card Verification Code Check (CVC) - checking the customer has the correct 3 or 4 digit code on the back of the credit card.
If either fails, there is a higher probability of credit card fraud.
One other thing to consider is using a payment provider with 3D Secure. This process is required in Europe but not mandatory in other regions. When used, you transfer the risk of the chargeback from your business to the card issuer.
In this article, we dove into the DSO and what areas an e-commerce business with credit sales can look at to improve this number.
We recognized that an online-only storefront could not speed up cash collection and their DSO once they utilized their provider's quickest payout policy. However, returns and chargebacks in the sales process do have cash impacts and are critical areas to consider for cash flow management.
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 firstname.lastname@example.org to reduce your cash stress.