I first began working with Amazon and other ecommerce sellers in 2015. As I learned more about the industry, I realized that too many sellers rely on credit card debt or other loans to pay for their inventory and operating expenses. Many are not paying themselves consistently, waiting until tax time to determine if they can take a paycheck.
As I’m writing this Hurricane Florence is ravaging the mid-Atlantic coast. There is no comparing the seriousness of a hurricane to business problems. But there are parallels. Residents in the hurricane’s vicinity wonder what path will the storm take, and whether they will lose power or worse, suffer property damage or physical injury.
The worries of ecommerce sellers are far less severe. But they are real, typically focusing on inventory. Is it the right inventory? Will it be enough? How will I fulfill orders and stay afloat during the busy season?
Making Money
For most of my clients, Q4 is critical to their profitability for the year. In early January, we’ll assess the quarter, similar to assessing hurricane damage once the storm clouds clear. Which products sold? Which products bombed and how will I move them? Did we make money? Do I have enough to pay the debt for my product, pay taxes, and pay myself?
Do I have enough to pay the debt for my product, pay taxes, and pay myself?
Amazon and retail ecommerce is a complicated business model because of inventory and the cash flow required to support it. Our clients that commit to and stick with the Profit First cash management method have learned how to weather the storms and achieve their profit and growth goals.
Profit First, created by Mike Michalowicz, who is also the author of the book, “Profit First,” works with human behavior and provides a framework to manage financial activity in a manner that builds in profitability. The behavior is called Parkinson’s Law. It was developed in the 1950s by C. Northcote Parkinson, a British naval historian. Parkinson proved that the consumption of any resource will rise to meet the quantity of the resource available. This applies to time, money, and any good or service.
Because of Parkinson’s Law, the traditional business equation of Sales – Expenses = Profit is destined to leave little left over. Thus the Profit First equation is Sales – Profit = Expenses.
The math works either way. From a behavioral perspective, if you don’t take your profit first, there will be none left over, as your expenses will rise to meet your income. In contrast, if you take your profit first, the funds left over for operating expenses will be less. This puts pressure on you to operate efficiently and frugally, and to be more innovative.
The ‘Profit First’ Method
Profit First follows a 4-step process.
1. Creating multiple bank accounts separates your cash into bank accounts created for specific purposes. Most businesses operate with a single checking account for all activity. Ecommerce sellers, however, should create two checking accounts: one for inventory and another for operating expenses. Additionally, sellers should create three savings accounts: for profit, owner pay, and taxes.
2. Following a prescribed sequence creates a new behavior around the bank accounts. As your ecommerce sales proceeds are deposited in your operating expense account, you will move funds into designated accounts based on a specific sequence.
- First, determine the cost of the products you just sold. Transfer that amount into your inventory account. This account will be used to replenish inventory.
- Next, move 1 to 5 percent (whatever your cash flow allows) into the profit account. In this way, Amazon sellers will be profitable with their next settlement.
- Finally, the remaining amount will stay in your operating expense account. Look at your expected expenses coming due and make sure you can cover them with the remaining funds. If not, look at what expenses you can cut or reduce. Initially, you may need to use low percentages for the profit allocation. But if you cannot cover your operating expenses, you may be living beyond your means.
3. Removing temptation is based on the realization that new behaviors are hard to learn and maintain. If a growing balance in your profit account is going to tempt you, move that money to an account that is less accessible, such an investment account at another institution.
4. Implementing a rhythm optimizes the time you will spend managing your funds. To understand the flow of cash, replenish the accounts as prescribed above in step 2 every two weeks. Most Amazon sellers, for example, receive payouts biweekly. So this rhythm already exists. Fund your accounts following the sequence, then pay any bills due before the next payouts. If you’re using credit cards and auto withdrawals, look at the upcoming payments and ensure that you will have the required funds.
This is an abbreviated description of the process. Follow it for a few months to understand the cash rhythm of your business. Once you have a routine and a few months of data, streamline the process by using percentages, for quick calculations on a spreadsheet.
In my experience, the shift in mindset works wonders for ecommerce sellers. As they begin to better understand their cash flow, especially as it relates to inventory, they gain control of their operating expenses. They can pay themselves. It’s like the sun is coming out, warm and bright after the storm.