Scaling your eCommerce by improving the working capital cycle

Learn about the financial structure of an eCommerce business and how you can improve your Working Capital cycle with RITMO's Invoice Financing solution.

Aided by the pandemic and large structural changes in consumer behavior, eCommerce has shifted from an emerging trend to an established economic growth driver. It is not the future any more but the very present. Online sales have gone from representing a tiny fraction of total sales for large retailers to becoming the focus of their strategic decisions and, in many cases, their main source of revenue.

But online commerce has not only impacted traditional retail groups. It has also opened up a new business opportunity for countless small businesses that have found in digital marketplaces a channel to distribute their products. For the purpose of the rest of this article, we will focus on this second type of businesses that have become commonly known as sellers or online sellers.

In the next paragraphs we will discuss the financial and operational structure of these businesses. Ultimately, we identify several pain-points and we present RITMO Invoice Financing, one of our solutions to solving these through innovative financial products which we have designed to help sellers improve operations and scale faster.

Financial Structure of Online Sellers

Online sellers are light business structures. And light here is meant from a balance sheet perspective. No intention to downgrade anyone's ambitions and growth plans here as the definition applies to sellers with annual turnover of €50m and €50k equally. They rarely have fixed assets and, when they do, these represent just a fraction of their balance sheet. In most cases, fixed assets are warehouses if they have chosen to have their own instead of leveraging third-party providers. In business school you learn that total assets are equal to total equity and total liabilities. The former represents uses of funds while the latter reflects sources of capital. With no fixed or long-term assets, there usually aren't high levels of long-term debt or equity.

So if there are no fixed assets and no long-term liabilities, how do these businesses operate? The answer is simple: working capital. Inventory and accounts receivables take the larger part of the uses of funds in a seller's balance sheet. There is typically little cash in their accounts as a result of their cost structure.

Unlike SaaS businesses (the other rising digital business model) where marginal costs decrease and eventually approach 0 (this is not exactly true but in a way it is), marginal costs for online sellers show an increasing trend. Costs are therefore very closely related to revenues. If you want to sell, you need to spend. In this case, if you want to sell, you first need to buy something that you can then sell. In the absence of large fixed assets, expenses for sellers are mainly operational costs related to inventory, logistics, software performance tools, marketplace fees, marketing and agencies etc.

What is Working Capital?

To-date, working capital is by far the largest challenge for sellers and the main barrier for growth. We will see later how an efficient management of these accounting items is the key for online sellers to scale. As a refresher, working capital is the difference between short term assets and short term liabilities. Positivity is good as an attitude in life, but bad in working capital. Positive working capital means you pay suppliers and short-term debtors sooner than you sell your inventory or your clients (or the marketplace) pay you. The working capital cycle refers to the time it takes a business to convert short term assets and liabilities into cash. For the purpose of this post, let's think of the working capital cycle as the time it takes since €1 leaves the cash balance as an operational expense until it comes back as revenue.

What do Sellers´ Operations Look Like?

Most European sellers get their inventory from either other European countries, India, or Southeast Asia, mostly China. Depending on where supplies come from, sellers are exposed to different shipment/delivery terms. These can go from 1 week all the way up to 8 weeks. Recent disruption in global supply chains has caused these timings to increase well above 8 weeks but for the sake of not overcomplicating things, let’s stick to 1-8 weeks.

Payment terms with suppliers vary depending on the size of the seller, the recurrence of purchases, the strength of the relationship, and the product type (products with long production cycles come with larger upfront pre-production payments). But most will include an upfront payment at the time the order is made of anywhere between 15% to 100%. This is the moment when the first cash outflow happens for a seller and when the working capital cycle begins. The remaining balance is paid either when merchandise is shipped or when it arrives at an European port. Sellers whose suppliers sit in Europe face substantially simpler operations and therefore working capital cycles. Those getting stock from abroad need to then deal with customs (and more payments and cash outflows) once their supplies get to the port in order to get them out of there and into their warehouses. This process takes, on top of more money, another 2-7 days best case scenario.

Sellers are now ready to start selling and are happy about that. It wasn’t easy to get here but they are starting to see light at the end of the tunnel. It’s a fairly long tunnel, however, and seller and sales proceeds are still a few weeks apart.

It would be great if a seller could synchronize its available stock at the warehouse with the different marketplaces (there is a huge list of these… like very, very huge) and then lay back and let sales just occur. Unfortunately, things still get a bit messier from here. The sales process will, in most cases, take a few weeks. Rarely less than 1, and commonly anywhere between 3 and 6. During this time the cash outflow continues. Attracting traffic to your products, PPC, product listing optimization… a strong positioning within the marketplace is more and more a full-time job and it is becoming quite common to use the services of an agency for this. Guess what? So far, more cash outflows, 0 inflows.

Eventually, sellers sell their stock. And just when they thought that they would see the proceeds from those sales hitting the bank account, marketplace payouts step in. Marketplaces retain those funds for 14 to 21 days (another 2 to 3 weeks). This is done to allow for a potential refund. But it also serves to finance the marketplace's own working capital. What is a positive (remember this is negative) working capital for the seller is a negative (remember this is positive) working capital for the marketplace.

If you did well enough to be able to sell directly to Amazon as Vendor then you are rewarded with payout terms that go up to 60 days. This deserves a whole new post so let’s not get into it here.

To summarize all of the above, the stock-to-sale process can take 4 weeks in a best-case scenario for lucky sellers, and 12-14 weeks for most others. That’s 12 weeks since a seller makes the first payment to a supplier until revenues hit the account. That’s also 12 weeks within which several other payments are required.

Finally, it is also worth noting the difference in size between the outflows and the inflows. Outflows are fairly large and happen in one go. On the other hand, inflows, or sales, are relatively smaller and happen over time.

Based on the briefly discussed cost structure of sellers and their working capital cycle, one can easily identify where the challenges for a seller come from: sellers need to wait for the marketplace payout to happen before they have available resources to stock up again.

How does RITMO Invoice Financing work?

1- Get an offer

Our platform leverages technology and data to understand a seller's business in minutes and come up with a financing solution in less than 24 hours. Simply by connecting the main sales platforms to our sales prediction engine, we approve a limit that can be used to pay all operational invoices. This limit is dynamic and will increase when the business grows to make sure sellers have the financial support they need to scale.

2- Upload invoices and have them paid

The seller uploads all invoices directly to our platform and we will pay them on their behalf. When doing so, the seller can choose a repayment period that goes from 4 weeks all the way up to 12 weeks and repayments will happen in weekly equal payments until full repayment. This allows them to fraction the payment of large (or small) invoices and avoid tension in their own treasury.