3 Costly Mistakes Related to Free Cash Flow
\What is Free Cash Flow? If you don’t know the answer to this question, then there’s a very real chance that you’ll run out of inventory, spend too much on advertising, and stunt the growth of your Amazon business.
Free Cash Flow (FCF) is the cash that your company has leftover after it pays for normal business operating expenses and capital expenditures, such as equipment. FCF can be a key indicator of your business’ health and profitability.
FCF is the capital that you can use to evolve your business growth strategy. You can invest it in short-term advertising campaigns and new products, or use it to hire new staff.
If you don’t have an up-to-date awareness of your FCF, you might stretch your capital too thin, which could lead to a stockout or put your advertising campaigns on hold. This article will provide a basic overview of FCF and discuss three mistakes related to FCF that could prove costly for your Amazon business:
Mistake #1: Not Calculating Free Cash Flow
Amazon Sellers often make the mistake of thinking, “Money in the Bank = Cash Flow = Money I Can Spend.”
Don’t make this mistake.
If you want to grow your Amazon business, it is important that you know the difference between money in the bank and your FCF. Before we dig too deep, let’s define the calculation used in determining:
Free Cash Flow can be calculated simply as:
Both sales revenues and operating costs and taxes can be taken straight from the business income statement while capital expenditures is the increase in fixed assets from the balance sheet.
Additionally FCF can be calculated as:
In this calculation, net cash flow from operations comes from the first section of the statement of cash flows and capital expenditures is again the increase in fixed assets from the balance sheet.
Both calculations will yield the same result and provided greater insight into the amount of funds leftover to expand your business, reduce debt or invest in inventory.
When you understand how to calculate you might realize that you have far less capital at your disposal than you thought. For example, let’s assume that you are selling garlic presses. You made $10,000 in sales revenue with $5,000 in operating expenses. That gives you $5,000 in net income. Additionally you purchased $2,000 in inventory for 1,000 units.
But your cash balance is only the $3,000 currently in the bank. Where did the $2,000 difference go?!
Well, you’re still waiting on Amazon to pay you that difference on the next payout date.
As you can see, there’s a big difference between the $5,000 in net income and the $3,000 that is available in FCF.
Mistake #2: Spending More Than 70% of Cash Flow on Your First Inventory Order Because You’re Afraid to Run Out
All businesses eventually incur unexpected costs. Your suppliers might increase their prices. The rent for your office or warehouse might go up. It is important that you have the funds to cover these expenses, which is why you should never spend all of your cash flow on inventory. This mistake is particularly common among new Amazon Sellers who make their first inventory
As a rule of thumb, you should never spend more than 70% of your cash flow on a single batch of inventory, though the actual percentage for your particular business depends on your specific expenses and situation.
For Example: Let’s say you’re ready to place your first inventory order and you only have $5,000 available to start selling on Amazon. It would be wise, then, to spend no more than $3,500 on inventory.
You can use the remaining $1,500 to pay for Pay Per Click (PPC) ads, shipping, UPC codes, salaries, product photography, and general business expenses such as software and legal costs.
It is equally important for experienced Sellers to track the percentage of their cash flow that they spend on inventory. This alone helped Michael get his Amazon business back on track and profit more than $150,000 last year.
Mistake #3: Not Creating an Emergency Fund for Your Amazon Business
It’s the moment that every Amazon Seller waits for—when the money in the bank raises to a comfortable level, and you’re tempted to cut yourself a hefty salary check. Before you pull the trigger, though, set aside time to create an “emergency fund” strategy for your business.
When developing your emergency fund, remember to factor in all of your recurring operating expenses such as compensation and benefits, consulting, and office rent. You choose the length of time the emergency fund should cover, but a good rule of thumb is to set aside enough money to pay for six months of recurring operating expenses.