Working Capital and Inventory: Optimize Cash Flow for E-commerce
The Working Capital Problem
Every dollar in inventory is a dollar you can't use elsewhere. For e-commerce sellers, inventory is often the largest working capital investment.
The question isn't just "Do I have enough stock?" It's "Am I tying up too much cash in products that aren't selling fast enough?"
Understanding the Cash Conversion Cycle
The cash conversion cycle shows how long cash is tied up:
Cash → Inventory → Sale → Cash (received)
The Formula
Cash Conversion Cycle = DIO + DSO - DPO
DIO = Days Inventory Outstanding (how long inventory sits)
DSO = Days Sales Outstanding (how long until payment)
DPO = Days Payable Outstanding (how long you have to pay suppliers)
E-commerce Example
DIO: 45 days (inventory sits 45 days)
DSO: 0 days (customers pay immediately)
DPO: 30 days (you pay suppliers in 30 days)
Cash Cycle = 45 + 0 - 30 = 15 days
Your cash is tied up for 15 days per inventory cycle.
How Much Capital Is Trapped?
Calculate your inventory investment:
Average Inventory Value = (Beginning + Ending Inventory) / 2
Compare to total working capital:
Working Capital = Current Assets - Current Liabilities
Inventory % = Average Inventory / Working Capital
Healthy Ranges
| Inventory % of Working Capital | Assessment |
|---|---|
| < 15% | May be understocked |
| 15-30% | Healthy range |
| 30-50% | Watch closely |
| > 50% | Capital efficiency problem |
The True Cost of Overstocking
Excess inventory costs more than the purchase price:
| Cost Type | Annual Impact |
|---|---|
| Cost of capital | 8-15% of inventory value |
| Storage/warehousing | 2-5% |
| Insurance | 0.5-1% |
| Shrinkage/damage | 1-3% |
| Obsolescence risk | 2-10% |
| Total carrying cost | 15-35% |
A $100,000 overstock might cost $15,000-$35,000 annually just to hold.
Strategies to Free Working Capital
Strategy 1: Improve Inventory Turnover
Higher turnover means less inventory needed:
| Scenario | Annual Sales | Turnover | Inventory Needed |
|---|---|---|---|
| Current | $600,000 | 4x | $150,000 |
| Improved | $600,000 | 8x | $75,000 |
| Capital freed | $75,000 |
Strategy 2: Reduce Lead Times
Shorter lead times = smaller safety stock = less capital:
Current: 60-day lead time → 90 days of inventory
Improved: 30-day lead time → 45 days of inventory
Capital freed: ~50% reduction
Options to reduce lead time:
- Domestic suppliers
- Air freight for fast movers
- Vendor-managed inventory
- Dropship for slow movers
Strategy 3: Apply ABC Analysis
ABC analysis prioritizes capital allocation:
| Category | % of SKUs | % of Revenue | Capital Allocation |
|---|---|---|---|
| A items | 20% | 80% | High investment |
| B items | 30% | 15% | Moderate |
| C items | 50% | 5% | Minimal |
Stop tying up capital in slow-moving C items.
Strategy 4: Just-in-Time Where Possible
Order smaller quantities more frequently for products where:
- Lead times are short
- Supplier minimums are low
- Demand is predictable
Trade slightly higher per-unit costs for freed capital.
Strategy 5: Negotiate Payment Terms
Extend DPO (Days Payable Outstanding):
- Net 30 → Net 45 or Net 60
- Supplier financing programs
- Trade credit
Every extra day of payment terms frees cash.
Strategy 6: Use Inventory Financing Strategically
For seasonal builds, consider:
- Inventory lines of credit
- Purchase order financing
- Revenue-based financing
Ensure cost of capital < gross margin and the inventory will sell.
Working Capital Planning by Season
E-commerce cash needs fluctuate:
| Period | Inventory Build | Cash Need |
|---|---|---|
| Q1 | Low | Lower |
| Q2 | Moderate | Moderate |
| Q3 | High (Q4 prep) | Highest |
| Q4 | Peak sales, depleting | Converting to cash |
Plan financing for Q3 inventory builds when cash converts in Q4.
Multi-Channel Working Capital Considerations
Multi-channel sellers face additional complexity:
FBA Inventory
- Tied up until sold
- Long-term storage fees penalize slow movers
- Removal/liquidation takes time
Warehouse Inventory
- More flexible but still tied up
- Can reallocate between channels
- Storage costs may be lower
Optimal Split
Balance FBA convenience against capital flexibility. Don't send everything to FBA if it will sit.
Measuring Progress
Track these metrics monthly:
| Metric | Target |
|---|---|
| Inventory Turnover | 6-10x annually |
| Days Inventory Outstanding | 30-60 days |
| Inventory % of Working Capital | 20-40% |
| Cash Conversion Cycle | < 30 days |
ReplenishRadar shows working capital impact alongside forecasting recommendations.
See which SKUs are tying up the most capital. Start a free trial and optimize your inventory investment.
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