Don’t Let Cash Flow Constrain Your Growth
Scaling a DTC brand is one of the most challenging journeys an entrepreneur can embark on. Along the way the business will be pressure tested in its ability to manage and leverage its vision, people, processes, and data. However, regardless of how well you manage these areas, if the business becomes constrained by insufficient cash flow, little else matters.
In this article, I will teach you the fundamentals of how to measure and improve your cash flow. The result will be a newfound ability to proactively optimize your cash flow, so you’ll never find yourself short of cash when your growing DTC brand needs it most.
The Basics: Cash Flow Drivers 101
In its simplest form, cash flow is driven by two main factors: profitability and the cash conversion cycle (CCC). Given how familiar brand founders tend to be with the drivers of profitability, we’ll focus our attention on the lesser understood, and arguably more important driver of cash flow: the CCC.
What is the CCC? The CCC is the number of days it takes a company to convert one dollar of purchased inventory into one dollar of cash received from sales.
The typical CCC formula is laden with accounting jargon. As such, I like to simplify the terminology as follows:
CCC = Inventory days + AR days – AP days.
- Inventory days: the average days of sales your inventory levels can support.
- AR days: the average number of days it takes to collect your receivables.
- AP days: the average number of days it takes to pay your suppliers for inventory.
What does the CCC tell you? In short – the lower your CCC the healthier your cash flow will be and vice versa. Why is that? The longer it takes for your business to convert one dollar of inventory purchased into one dollar of cash received from sales, the longer your cash is sitting idle in one of three places:
- Warehouse shelves (Inventory Days)
- Your customers’ bank accounts (AR Days)
- Your vendors’ bank accounts (AP Days)
A Few Tips for Improving Cash Flow Drivers
Now that you have a basic understanding of the drivers of cash flow, it becomes much easier to see that insufficient cash flow is driven by:
- Insufficient profitability
- Excess inventory on hand (Inventory days are too high)
- Excess, slow turning receivables (AR days are too high)
- Paying vendors too quickly (AP days are too low)
So, what can you do to turn insufficient cash flow around? Given that I see most DTC brands struggle with the inventory days and AP days components of the CCC formula, I’ll offer a few tips for how to free up cash by reducing inventory days and increasing AP days.
Tips for Reducing Inventory Days
1. Create a simple inventory health scorecard that reports total on-hand value and days inventory on hand for each SKU and review it at least monthly. You'll be surprised by how simply being aware of these metrics will improve your inventory planning decisions.
2. Hold a weekly cross-functional planning meeting that brings together sales/marketing, operations, and finance team members. Use the meeting to review and gain cross-functional alignment on four key areas that make-or-break inventory purchasing decisions:
- Month-to-date sales actuals versus forecast
- Month-to-date advertising spend efficiency actuals versus forecast
- Projected SKU replenishment requirements
- Weekly cash forecast for the next 2 to 6 weeks
Tips for Increasing AP Days
2. Consider working capital financing solutions that mimic vendor payment terms. If vendors won’t offer sufficient terms to enhance your CCC, consider working capital financing products like Ampla Pay Later, which mimics the CCC impact of vendor payment terms for a small fee. Products like this can be a huge growth unlock for early-stage brands that don’t yet have the relationships and leverage with their vendors to negotiate payment terms.
Armed with an understanding of your major cash flow drivers and several tips for improving them, your future, cash-rich business awaits you. Don't delay, get started now! If the thought of diving into your financial data to break down your profitability and calculate your CCC overwhelms you, and you don't have a CFO on your team, consider hiring a Fractional CFO to help.
At Free to Grow CFO we provide founders of growing DTC brands the financial insights they need to make fast, effective decisions with confidence. And - improving cash flow drivers is one of our specialties. Whether you choose to enlist the help of a Fractional CFO or take a stab at it alone, embarking on the journey of improving your growing brand's cash flow is guaranteed to be a meaningful and worthwhile step toward achieving your growth goals.
Until next time, scale on!