How to Understand Your Ecommerce Cash Flow Statement

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Here at LedgerGurus we know the often untapped power of financial statements for our clients. We understand the questions that they answer and how they can make you better business owners by really understanding what's going on with your business. So we encourage you to dive in. And even though accounting jargon can kind of scare people off and make them want to cry, there is such value in understanding it that we really encourage you to dive in.

The cash flow statement in particular is a valuable tool for seeing how it all comes together, and how all pieces of your financial picture fit together into one piece. So let's dive into how to understand your ecommerce cash flow statement.

1:04 Cash, profitability, and the cash cycle

So the first thing I want to talk about is the fact that cash is king. As a business owner I'm sure that we understand that to be true. But what people often misunderstand is that cash and profitability are not the same thing.

Income statement is typically where we see the profitability of the business, but profitability and cash are not the same thing. There's a lot of reasons why that's true, but one great example that you guys probably relate to is inventory.

So inventory is typically supposed to be put on the balance sheet when it's purchased, and then expensed over time through cost of goods sold as that item is sold. However, that doesn't mean that you can wait until you've sold the item to actually pay your vendor for them. You usually have to buy that in advance. And then there can actually be a fairly long delay between the time that you actually pay your manufacturers to produce and ship the product, and the time that you actually convert that money back into cash.

And that's a great example of where profitability, tracked with a correct cost of goods sold allowing you to see your margins correctly, is completely different from the movement of the business's cash.

2:01

So I want to talk first really quick about this cash cycle, because it does affect ecommerce businesses so egregiously. Because you guys are so often not manufacturing your own product, and in fact are usually manufacturing your product from outsourced manufacturers that are quite far away, and so your delay on this can be long.

So you order your product, and at the time that you order the product you're at least having to make some sort of prepayment, a deposit of some kind. And so then the product ships, and typically that's when they're requiring for you to finish paying for whatever product. But even after the product is shipped, then you still have to receive it, you have to store it, until at which time the product is hopefully eventually sold. And then at the time that it's finally sold you get the money back in for selling your product, and then you start the cycle all over again.

So this is the cash cycle, but this is where money goes out and it's a long time before the money comes back in. So managing this cash cycle is one of the primary reasons why we wanted to teach you guys about the cash flow statement, and how to use it to cash plan and to evaluate how all this goes.

3:08 What a cash flow statement is

So what is a cash flow statement? A cash flow statement is a statement that is made up of the information that comes from the profit and loss and comes from the balance sheet. And it's really a statement that shows you the movement in and out of the business from the cash. Shows the money coming in, shows the money going out, and it's a place where the entire picture of the business all comes together.

Why is it important to small businesses? So it gives you great visibility. It helps you stay afloat, it helps you plan. So especially around the cash planning around the cash cycle that we've talked about.

If you don't plan these things, it can be really problematic. Like not only do you need to plan how you're going to get the cash to make sure you live through that cycle, but also how far in advance do you need to place orders, so that at the time that your inventory is running low in your warehouse you have a new shipment coming in.

3:58

Also, we've seen some of our clients, those who didn't plan cash very well, really negatively impacted by ordering way too much inventory and then having to sit on that inventory for an extended period of time, incurring the warehousing costs and not being able to move that inventory quickly enough, and it then hits their margins.

It also allows you visibility into cash and where the cash is coming from and where the cash is going. Allows you to operate with more integrity. And I don't mean that in like, you know, you're going to go rob a bank because you ran out of cash, even though you might be tempted to do that.

What I mean is that if you have investors, or you have the ability to put money into the business yourself, it can be easy to seek cash flow from other methods in order to keep the cash of the business afloat. And if you're not completely aware of whether or not the operational activities of your business are creating a cash positive experience or cash negative experience, you can lose the ability to manage cash positive and rely instead on other sources to try to keep your business afloat without even realizing you're doing it.

5:04 Three types of cash flow and two methods

So to that point, there are three different types of cash flow.

The first one is operating cash flow, and this is the cash flow that comes as a direct result of the activities of your business. Buying, selling your product, overhead, paying your payroll, paying your utilities, paying for your marketing expenses. Typically all the things that are flowing through your profit and loss statement are all things that are touching operating, with just a couple of exceptions.

The second one is investing, and this typically has to do with the buy and sell of assets of the business. So if I have a warehouse, you know, maybe I put down a down payment to get a new warehouse, or maybe I sold another warehouse and I received the cash from that sale and bought another warehouse and had to do another down payment. Maybe I have machinery that I'm using to manufacture my product.

The third type of cash is financing, and that is money that basically comes from either partners or investors or from outside lenders. So loans, equity contributions, those are all things that flow through financing.

6:05

So there are two main types. If you were to just Google cash flow statements and you were to pull up some images, you would see lots of different examples of it. But really there's two primary structures of the way that this information is being presented.

The first one is called the direct method, and it basically says, here's all the money that came in from sales that were made and the money that was collected from those sales, and here's all the money that was paid out for expenses. This is typically very easy to understand and it's very straightforward. However, it's very hard to create from the data you have available to you.

The second one is called the indirect method, and it starts with net income, and then you add in or subtract back in all the cash impact from different operating activities.

6:47

So this is an example of what the two of these look like. So this one here on the left is the direct method. Money from customers, money paid to suppliers, money paid for this, gives us our total net cash. Over here we have the indirect method, which we start with net income and then we add or subtract back in all the reasons why net income is not the same thing as cash.

And so typically this net cash, no matter which way you do it, is going to end up being the same. Sometimes when you're just looking through this and viewing this, this can be a lot easier to understand. However, this method is the one that QuickBooks defaults to. And after you understand what you're looking at, it can actually be extremely valuable, because net income is a number you should also be looking at, evaluating. And this one takes net income and then converts it into net cash, which I personally feel like is an extremely useful way to present this information.

7:55 Projecting cash and reading it in QuickBooks

One of the things that I feel like is most valuable to cash flow statement is the ability it gives you to project cash, not only now but in the future. So if you know you're going to run out of cash six months beforehand, you can take action to allow you to adjust.

So what are the benefits of a healthy cash flow statement? Number one, it gives you lack of stress. If I know now that I'm going to run out of cash six months from now, I can take action, whereas if I don't know that I'm going to run out of cash until two weeks before it happens, my options are a lot more limited.

Because it allows you to plan for fires and emergencies long before they ever happen. It also increases the opportunity and the things that you can take advantage of. Allows you to engage in different key partnerships, and it allows you to invest in good marketing opportunity when the ROAS is there. So when I can see that my return on my ad spend is really good, if I'm planning healthy cash flow and I have good cash flow and I understand exactly what my cash needs are, I can take advantage of ramping up marketing opportunities, even though I know it's going to take me a while to convert that back into sales.

8:44

So let's take a look at the cash flow statement as it comes out of QuickBooks and explain how to understand this.

So I come over here to reports. I've already favorited it, it will be up here in the favorites. And if I haven't favorited it, then it'll be down here in business overview. In order to favorite it I just click that green button and then it'll come up here and stay here.

So I'm going to click on the statement of cash flows, and I'm actually going to back this up a couple of years, and I'm going to have it display this data by months, and then run this report.

So as I mentioned before, there's an indirect and a direct method of presenting this data. QuickBooks defaults to what's called the indirect method. So this first line item here is net income, and everything below this is all the reasons why this net income from an operating perspective does not equal cash.

9:31

So in our businesses we have something called accrual accounting typically. Accrual accounting is the best way to do your accounting, and what that means is we're not just looking at the cash that's moved in our bank account or credit card. We're not just evaluating what money people have paid us and what's deposited into our account. We also want to keep track of money that people owe us and money that we owe other people.

So that's the primary difference between cash accounting and accrual accounting. Cash just looks at the movement through the bank accounts and credit cards, and accrual looks at what is really going on in the business over and above just what's moving through the bank account.

10:07 Accounts receivable and inventory

So accounts receivable is a great example of this. Now not every single ecommerce business has accounts receivable. Accounts receivable is very common in ecommerce businesses if you have wholesale relationships as well. Maybe you're selling into boutique shops, or Dillard's or Nordstrom or Best Buy or Walmart or whatever it is you might be selling. They send you a PO of what they want, you fulfill that PO, oftentimes they expect some kind of terms like 30 to 60 days before they have to pay you. So you want to keep your eyeballs on what they owe you even if that money hasn't come in the door yet. That is where we track something called accounts receivable.

However, accounts receivable indicates sales that have been made but the cash has not yet been received. And so accounts receivable is one of the primary ways in which there's a difference between what we show from a net income perspective and what we actually show from a cash perspective.

So in this case, in the case of this April here, our accounts receivable is creating a negative adjustment to cash of 55,000. So basically what that means is that in the month of April our accounts receivable balance went up, which means that we had another 55,000 worth of sales in the month of April over and above what we actually collected previously from other customers for accounts receivable in the past. So because 55,000 of sales came in that we were not paid for, over and above what we collected, cash is adjusted downwards by 55,000 because of that change in accounts receivable balance.

11:36

Now sometimes accounts receivable balances will adjust cash down, sometimes they'll adjust cash up. So if we look over here in July, we see that this month accounts receivable actually adjusted the cash balance up by 250,000 over and above what we did in net income. So in this case we collected 250,000 in cash over and above what we actually sold through those types of relationships that create an accounts receivable in that particular month.

So this month it adjusted our cash up, this other month it adjusts our cash down. If you don't have accounts receivable relationships and all you're doing is selling on channels, you will never have this kind of differential. But if you do have invoices, then just because you sold doesn't mean that you collected on the money. And sometimes you get ahead on receivables and you catch up and you're able to collect more. And that's exactly what's going on here.

12:26

So then the next line item on here is we see inventory. So as you guys know, inventory management and the cash around inventory management is an extremely complicated thing for ecommerce businesses, and fraught with risk and terror and mayhem.

So the right way to track inventory from a profitability perspective is that you don't expense it right away through your profit and loss statement. You typically put it on your balance sheet, and then at the time that it's sold, then it's expensed through cost of goods sold. Just because you're waiting several months until it sells to actually expense it through cost of goods sold doesn't mean that you're paying for it that way with your vendors. In fact you're usually not, you're usually paying upfront for inventory. And inventory planning is one of the primary reasons to plan your cash.

So in this case we bought from our vendors 338 thousand dollars worth of additional inventory in this particular month. If we look forward over here we can see that in the month of December, not surprising, we actually sold a massive amount of our inventory that we had been previously buying up. So you see, preparing for the busy season, we're buying it, we're investing the cash, investing the cash, investing the cash, and then in December this cash cycle completes itself when all of this product sells.

And now this is over and above what was actually, like in the month of December from a profitability perspective we may have incurred all of the cost of it, but the cash of it came roaring back in. So that's why you see negative, negative, negative inventory, huge cash from converting that cash into sales in the month of December.

14:02 Liabilities, financing, and the bottom line

So right below here we have all of these liabilities. If you think about it, we use our credit cards all the time to delay the cash outlay of paying for expenses, but those expenses are still hitting our profit and loss statement. And so this number here reflects the decrease of profitability based on those expenses that hit. However, if I put that money on my credit card, that cash did not actually go out the door when I incurred those expenses. So that's why we have adjustments back on things like liabilities, is because this kept us from having to pay out cash even though we incurred the expenses.

So the next AMEX card though, down, you can see it looks like they're trying to kind of get ahead and pay down this credit card. So this means they had almost fifty thousand dollars that they paid towards this credit card over and above the expenses that were actually incurred in that particular month.

Now to be perfectly honest with you, this is actually very challenging to do, and I'm really glad that QuickBooks now does this for you. When I was in college getting my masters of accounting degree, cash flow statements were always something that I don't think I ever on a single test got 100 on a cash flow statement that I had to create, because this process is very complicated. It's kind of a pain, but it's so valuable to see this information. I'm just really glad that QuickBooks does this now.

15:20

So one of the ways that it's really valuable to see this information is, take a look at this month here. We had this huge month where we had 744 thousand dollars in net income, but negative impact of 493,000. Most of those sales were never collected on, we had made a huge cash investment in preparation for the busy season.

How in the world is this business staying alive? You see they had nine hundred eighty one thousand dollars of negative impact to cash in a month that they had seven hundred and forty four thousand dollars of positive net income.

Well, that's why the value of having it broken out in this way gives you great eyeballs and encourages you to operate in a way that allows for sustainability.

16:47

Because as I look down through here, all of this stuff here is just dealing with cash from operating activities. But down below we also have our investing activities and we have our financing activities.

So this particular set of books, because a lot of our ecommerce clients don't actually do their own manufacturing, a lot of our clients don't do a lot of their warehousing, as a result they don't have a lot of these fixed assets that they're buying and selling, which is what typically flows into investing activities. However, they have a lot of financing activities based on having to get loans to pre-buy inventory and stuff like that. So in this case we see that they got a 400,000 loan from Amazon that helps them from a cash perspective to stay afloat on this.

So down below here we see all of this use. We see negative, negative, negative, negative operating activity. So based on their cash cycle that we talked about earlier, you know, they struggle, they struggle, they struggle, and then in December and January typically they get all their cash back when they make those huge sales. And so they have to kind of survive in the meantime, and as a result they have loans that they take out, or they have equity contributions that they're making, or draws that they're making.

So this is the way this is laid out. Operating, investing, and then financing activities. And down here we see net cash provided by each one of these, and then the net increase or decrease in cash overall.

18:15

And so I can see why my net income number is not equaling my cash number, and I can dive in and understand.

Now one of the things that's important to understand is, if you are not operating cash positive from an operating income perspective, you'll eventually run out of cash. You can't survive on financing and investing activities indefinitely. The profitability of your business has to eventually sustain you. I mean, it's fine if there's like a fluctuation on this, or a seasonality of it, but in general, if you are not cash positive on an operations perspective, you will eventually go out of business. Because you can't indefinitely rely on people continuing to give you money if you're continuing to burn it, and eventually you'll run out of assets to sell to keep yourself cash positive.

If you would like some indicators on whether or not the financial statements that are flowing into your cash flow statements are correct and accurate, then download our PDF, 5 Signs of Bookkeeping Trouble with an Ecommerce Business. It will help you understand whether or not your bookkeeping right now is a good reflection of what's really going on with your business.

And if you're approaching a million dollars in annual sales and you're really struggling with your ecommerce bookkeeping and accounting, and you'd really like some more guidance on how to plan for cash issues and to bring all the financial pictures together in one place with a high degree of confidence, then feel free to reach out to us through ledgergurus.com. That's exactly what we do. We'll get you back on track with clean books and get you up to speed.

If you like this video, please hit the like button, be sure to subscribe, and share it with all of your ecommerce business friends who are all trying to figure out exactly the same things that you're trying to figure out. May we all succeed together, and we all have bank accounts that are full of cash. Thank you so much and have a great day.