The inventory financing problem is a different problem for online retailers. Traditional retailers can see the customers approaching the doors while the inventory problem waits for them. For online retailers, there is a delay. The outflow to the suppliers happens weeks or months ahead of the inflow. The impact of this gap creates a stress that stifles growth even when the business seems to be doing well.
Most online store owners learn this lesson the hard way. They find a product that sells well. Sales explode, and then they hit a wall. When it comes time to reorder, they need cash that they cannot get back in 30, 60, or 90 days. Their ad spend goes out every day. They keep having to pay platform fees, and their shipments keep piling up. It looks like they are running a successful business, but the bank balance tells a different story.
The Inventory-Cash Flow Gap
What makes this problem unique? The rate at which an online store’s need for inventory scales outstrips the pace of its cash flow. If your online store generates $50,000 in sales in a month, you need $20,000 to $30,000 in inventory on hand at any given time. If it takes 45 days for that inventory to become cash and another 15 days for the cash to reach you (thanks to holds by payment processors and customer returns), the cash is stuck in the system for two months.
It gets even worse if your store is growing. If your sales double, your inventory investment doubles. However, the cash generated by those sales has not finished doing its job yet. Your business is healthy but it cannot access the cash it needs to finance its next big purchase. Financial planners refer to this condition as a working capital squeeze.
Solutions That Work
Many solutions exist to this problem. Smart online retailers have all of them to choose from. The secret is using financing options that make sense for an ecommerce business and do not force its operations into the straightjacket of a traditional financing model.
Some retailers use niche ecommerce lending solutions who understand the timing problem posed by ecommerce retailing. Many different lending products consider the sales patterns and sales data from retailing platforms rather than adhering to traditional retail credit scores and physical assets. The vetting process also happens quickly because these lenders can verify sales data on integrated platforms instead of subjecting applicants to the standard ordeal of requesting tax returns and bank statements.
Another option many ecommerce retailers use is purchase order financing. This solution gives the retailer as much cash as they need to fulfill an order if they have a purchase order but not enough cash to pay it. They pay it back once their orders arrive and their customers pay for them.
A third option is revenue-based financing. Rather than paying back a fixed installment every month that stings every time sales dip, these retailers pay a fixed percentage of their daily or weekly revenues to the lender. Their payments drop every time their revenue drops. When they hit another growth spurt, their payments spike—but so does their ability to pay.
Inventory Management Practices That Reduce Inventory Financing Demand
Smart financing can help solve the cash flow problem faced by many retailers who operate ecommerce stores, but many successful operators use practices that reduce their need for inventory financing in the first place.
It all starts with forecasting. Retailers have various tools at their disposal to decide how much inventory to buy. They use historical performance data, and spreadsheets, and algorithms that search for seasonal and other patterns. Every retailer learns the value of ordering just the right amount of stock at the start of their career. Over ordering triggers unwanted cash flow problems. Underordering causes stockouts that ruin the positive momentum with their customers.
Many retailers also drop ship some or all of their products. It may not be the most satisfying solution for all products, but successful retailers work with a hybrid model: they drop ship slow-moving or experimental products while ensuring that they keep their stores’ bread and butter products in stock.
Another solution for the cash flow problem is to negotiate better payment terms with suppliers. Changing supplier payment terms from payment on delivery to net-30 or net-60 arrangements effectively gives the retailer free financing. If their product sells out before they have to pay their supplier, they never have to worry about getting cash in time.
Retailers can usually negotiate better terms once suppliers notice that they can keep moving product.
Another practice smart online retailers follow when ordering inventory is not just waiting for a reason to order but planning their order timing around when cash will flow into their business rather than when it will go out. They place a big order right after a good sales season instead of waiting until they are flush with fresh product ideas.
One tactic some retailers use to manage their cash flow around product order placement is negotiating with their suppliers to split a big order into multiple deliveries. The first delivery lands and starts selling off the shelves. By the time the second delivery arrives, the first shipment has deposited enough cash for the retailer.
Build a Cache of Opportunity-Specific Capital
Here is how to tell which ecommerce retailers will expand smoothly and which ones will struggle: they have a cache of capital set aside for specific opportunities that may arise in the future. If a retailer finds another hot product that unexpectedly sells well or if they find a supplier who offers to sell them a high-volume product at a steep discount, access to reserve capital opens up possibilities without placing stress on their cash flow management system.
The amount of capital they store away does not have to be earth-shattering. Even 25% to 30% of their regular monthly requirement can give these businesses enough leeway to ride the waves that exceptional opportunities create without going through financial distress. With this cache, these retailers do not have to max out their lines of credit or search for emergency financing options before they can grab a once-in-a-lifetime opportunity.
The ecommerce retail model will always create an opportunity problem regarding timing the flow of cash that customers generate before they buy products. However, the difference between retailers who get stuck at a particular revenue figure and those who do not is whether they have solved the problem of financing inventory costs.
By knowing how financing options providers have recalibrated their offerings for this market, and by designing their operations in a way that minimizes their need for these services in the first place, retailers can make growth patterns familiar instead of traumatic.
