Working capital is the make-or-break force behind retail success. It enables your brand to invest in growth initiatives, cushion unforeseen challenges, and capitalize on new opportunities.
But if you’re like many direct-to-consumer (DTC) retailers, inventory is tying up most of your working capital. More specifically, inventory that either hasn’t arrived yet or has turned into deadstock. And both can cause huge problems for your brand’s longevity.
Let’s walk through how working capital gets tied up. And, more importantly, how to free it.
What is working capital?
Working capital is the money used to finance the day-to-day operations of your business. And it can be either “tied up” or “untied.”
Tied up working capital refers to the money already being put to use. For example, it might have been used to pay for a recent supplier invoice.
Meanwhile, untied or free working capital refers to the available money you have yet to use. With it, you develop new product lines, hire more talent, improve your marketing game, and more.
What happens when your capital is tied up?
When your brand’s capital is tied up, you can’t operate agilely or grow intentionally.
For instance, DTC sales are up more than 31% YoY and hardly slowing. This poses a huge revenue opportunity for your brand. But only if you have the working capital available to meet these growing demands despite a disrupted supply chain.
But say your working capital is tied up in profit-draining activities (like incoming POs and deadstock). Then, you might be strapped for cash when an opportunity to capitalize on this opportunity arises. Or, you might be simply unable to scale and meet demand.
And while not having enough cash might just sound like you might miss out, it could actually be a fatal mistake for your brand. In fact, lacking capital was the #1 reason small businesses closed shop in 2021.
The 2 ways most retailers tie up too much capital
As I mentioned earlier, most working capital gets tied up in inventory. Specifically, inventory that:
- Hasn’t arrived yet. Whenever you place new purchase orders (POs), you owe part of that cost upfront, and the rest is due within (usually) net 60 days. But with most industries currently facing ~6 month lead time, you end up cash negative (and don’t have the inventory on hand to sell) for ~4 months.
- Turned into deadstock. When you miscalculate demand and order too much of a SKU, that stock gets stuck in a warehouse, accruing holding costs. DTC brands hold roughly 33% of deadstock in their active inventory (well over the recommended 15%). And since this inventory isn’t selling, it’s just trapping capital (and costing you money).
Both can be fatal mistakes for your brand. And with today’s ongoing supply chain issues, it’s easier than ever to accidentally tie up too much working capital. This is especially true if you’re a bootstrapped brand that doesn’t have fundraising padding your expenses.
Take Weezie, for example. The bootstrapped brand sells monogrammed towels and robes, and last year, the team celebrated its first profitable, 7-figure year. But now, the brand is debating taking on debt to ensure that they have the capital needed to keep growing.
“The most expensive part of [DTC] growth is buying inventory and having to buy it so far in advance,” Weezie co-founder Lindsey Johnson told Modern Retail.
So, to offset today’s challenges, the towel brand recently hired a team of demand planners. These planners will help forecast exactly how much stock the brand needs and when. This way, they’re not tying up working capital in inventory if they don’t have to.
Luckily, you don’t have to hire a team of demand planners to optimize your inventory and free up working capital (you can, but definitely don’t have to).
3 steps for freeing up working capital
Freeing up working capital comes down to 3 easy steps:
- Accurately forecast demand
- Negotiate flexible payment terms
- Flip the cash conversion cycle
Let’s break down each step in the process.
Accurately forecast demand
Forecasts tell you how much inventory you need to order to fulfill demand. So, if your forecast is off, you’ll likely end up with too much stock (deadstock) or too little stock (stockouts). Both tie up working capital.
Luckily, bottom-up forecasting methods create accurate demand projections by first determining the brand’s baseline inventory needs. Then, cautiously layer on a few key growth assumptions.
Some brands do this with spreadsheets. Their ops teams plug in past data (if they have it documented), inventory trends (if they spot them), and marketing events (hopefully) to project future demand.
However, this option is prone to human errors, which throw off the final forecast. Not to mention it’s needlessly time-consuming (sometimes taking several weeks to build).
Cogsy, on the other hand, can build your forecast in minutes using your historical sales, inventory trends, and current stock levels. Then, it tracks your brand’s performance to see how it compares.
Every time new information is introduced (like an unexpected spike in demand or longer leads times), the tool automatically reflects it in the forecast. As a result, Cogsy’s forecast is wildly more accurate than anything built with a spreadsheet.
Even better, the tool takes the next steps and translates the forecast into a workable operational plan. That way, you know how much inventory to order and when to meet this demand. Every time your forecast updates slightly, your operational plan does too. So you’re only tying up the bare minimum working capital.
Manufacture products on flexible payment terms or inventory financing
Everything in business is negotiable – that includes your invoice terms. So, if right now, the supply chain is tying up capital in inventory you can’t sell for months, why not renegotiate payment terms that work in your favor? Ideally, ones that tie up less working capital upfront and stagger payments.
Here’s how I recommend going about this:
- Using your forecasts, map out the timing and sizing of future POs (alternatively, Cogsy’s production planning feature can do this for you).
- Ask your current supplier to renegotiate terms, and share this production plan as leverage.
Then, if you buy goods seasonally (meaning, you buy 3-4x per year or your SKUs change constantly):
- Commit to placing most of these mapped-out orders with them, but make it clear you won’t provide a downpayment now.
- Negotiate prices based on annual committed volume and split POs – so if you order 3-4X per year, split that into 10-12 POs that you can manage around inventory.
- Avoid committing to finished inventory and build intermediate / raw material inventory so you can remain flexible if SKUs underperform.
- Ask for extended terms, so your last payment against each PO pushes into the next PO, and you can overlap inventory.
Or, if you buy goods perennially (meaning, you buy throughout the year and see occasional spikes in demand based on seasonality):
3. Work out inventory and raw material forecasts to lock in material costs to ensure prices don’t go up over the next few months.
4. Offer the vendor an MFN (most favored nation) agreement that allows them first right of refusal if you get a lower price from a competitor during their contract. This will also let them charge a higher price if you pay that same price to another vendor during the contract.
5. Offer weekly payments based on milestones instead of larger sums based on individual POs where you place one annual PO instead of multiple smaller POs.
Does this really work? Sure does – Cogsy customers have reduced down payments to vendors by 50% by negotiating terms this way. This frees up working capital upfront, allowing these brands to operate more agilely.
But, if your manufacturer says no, no biggie! You can always alternatively rate shop with other manufacturing partners using a tool like MFDAdvanced.
MFDAdvanced is an end-to-end manufacturing solution with flexible terms. You get access to expert sourcing agents, supply chain expertise, and flexible payment options. This way, you stock more inventory at a lower cost and free up that working capital.
Plus, MFDAdvanced offers flexible payment options. So, you can still buy the inventory you need now without throttling your cash flow. And that means you can put more of your cash toward growing your business.
Flip the cash conversion cycle
Most DTC brands measure their cash conversion cycle (or the number of days it takes to turn what you invest in inventory into cash flow). The shorter the cash conversion cycle, the faster you free up working capital.
From start to finish, this cycle includes ordering stock, paying for it, then selling it to customers. However, you can flip this cash conversion cycle by selling on backorder.
Backorders allow customers to buy products you don’t yet have in your inventory but know are on their way. And it shortens the time it takes to complete the cycle, keeping cash flow positive, even when you’re waiting on POs.
Take popular cookware brand Caraway, for example. During the unprecedented spike in home goods sales, the brand couldn’t replenish its inventory fast enough. And the brand went out of stock pretty regularly (which is pretty much every retailer’s worst nightmare).
However, there was never a point when Caraway went cash flow negative because they sell on backorder with Cogsy. This keeps revenue flowing even during a stockout, making it easier to buy more inventory and ensuring there’s working capital available if needed.
What you can do with free working capital
Once you free up working capital, the possibilities are pretty much endless. For example, you can leverage your working capital to focus on growth, experiment, save for a rainy day, or extract value.
Focus on growth
With more cash on hand, you can use that cash to make more money. How? By doubling down on the growth channels that are already working.
Perhaps, the most obvious route is dumping more money into your paid acquisition channels (like Facebook or Instagram ads).
Sure, this might increase revenue. But, it’s probably not the best move with customer acquisition costs (CAC) at an all-time high. So, you might just end up burning through your newly freed-up capital.
Alternatively, you could invest in low-CAC activities, like:
- Creating organic content (like SEO long forms or a newsletter), which takes a bit longer to acquire customers but secures more qualified customers for a lot cheaper
- Hire a few more talented people, freeing up your team’s bandwidth and creating space to try acquisition strategies that don’t necessarily scale
- Update your website, making it even easier for customers to find what they need and complete their transactions (which tends to increase sales)
- Test new channels to see if there’s a more effective, cheaper way that your brand can acquire qualified customers (like an offline experience or wholesale)
With more cash reserves available, you can capitalize on new opportunities or ideas as they come about. Especially fortuitous ones that might not be possible or comfortable without extra cash on hand.
For instance, you might want to spin up new product offerings to expand your customer reach (or give existing customers a reason to come back sooner).
But research and development (R&D) are expensive up-front. But the upfront investment pays for itself if you create an incredible addition to your product offerings that customers actually want to buy. So, having freed-up cash to support the initial R&D is critical if you’re going to get it right.
Plus, with more cash available, your brand can make a few riskier bets that could unlock massive growth.
Skims also recently landed a major partnership with Team USA, providing loungewear for the Olympians. And they expanded into swimwear this year. Both experiments are positioned to be big moneymakers for the brand and wouldn’t have been possible without cash reserves.
Save for a rainy day
The ecommerce industry has seen incredible changes over the last 2 years, from a massive increase in customer demand to rising supply-chain issues. But when brands have access to working capital, it creates a safety margin to help weather the storm or a sudden downturn.
You could, for example, use your safety margins to offset today’s supply chain issue — such as by partnering with more expensive, local suppliers to cut down lead times. This strategy is proving to be particularly helpful as lead times continue to increase.
But your brand can also use these saved funds to give back to the community and share your team’s values. For example, many companies are using extra working capital to support Ukraine right now:
- Tombolo launched a new Ukraine flag-inspired cabana shirt and donated 100% of the sales.
- L’Oreal partnered with nonprofits to provide up to €5M of care packages to refugees.
- FedEx delivered $1M+ in humanitarian assistance programs.
- Lots of other brands have stopped operating in Russia for the foreseeable future.
Brands with good cash flow can extract value and return it to employees. One way to do this is by increasing salaries via an employee profit-sharing program. Bob’s Red Mill, a whole-grain foods brand, is famous for profit-sharing.
Their employees get monthly profit-sharing checks on top of paychecks, boosting employee morale and retention. And since April 2020, the company has become 100% employee-owned. But this program wouldn’t be possible without working capital.
But you can also take profits out of the company through dividends and distributions, then return them to your shareholders. This depends on the appetite for returns and the business’ mandate.
What will you do with your free cash flow?
Now that you know all the incredible things you can do by uniting your working capital, what’s stopping you?
I won’t lie and say freeing up working capital will be easy. But having the right tools (like Manufactured and Cogsy) makes it a lot easier.
For instance, Manufactured keeps your operational costs down by partnering you with the right manufacturers. Plus, providing flexible payment terms or inventory financing.
Finance Inventory, Grow Your Revenue with Manufactured
About Manufactured (MFD)
Founded in 2017, Manufactured helps companies source, finance and manage inventory across 20 industries and 25 countries. With over 45 years of experience, our goal is to simplify the inventory cycle for businesses of all sizes and industries. Companies can easily scale their manufacturing, lower unit costs, optimize supply chains and allocate capital efficiently. To learn more, visit www.manufactured.com