#400 – It’s Time To Know Your Numbers Before It’s Too Late with Jeff Lowenstein
What if understanding your financials could make or break your e-commerce success? Join us as we chat with Jeff Lowenstein, a seasoned fractional CFO, and former aggregator M&A specialist, who reveals why knowing your numbers is the cornerstone of profitability in today’s competitive market. We explore how Amazon’s fees, which can eat up to 65% of sales, make sophisticated financial planning an absolute necessity. Jeff shares his invaluable insights from corporate finance and e-commerce, emphasizing how accurate financials can attract investors and stave off business failure.
We navigate the intricacies of forecasting and due diligence during acquisitions, touching on our team’s philosophy of maintaining a high close rate as a strategic tool. Jeff dives into the necessity of blending quantitative metrics and qualitative insights, such as market trends and unforeseen variables like fluctuating interest rates and emerging platforms like TikTok Shop. We analyze how detailed financial modeling and robust market analysis can power business valuation and growth, underscoring the importance of adaptability in an ever-evolving landscape.
Finally, we explore the significant role of fractional CFO services in e-commerce, highlighting how they differ from traditional accounting. Jeff explains how a fractional CFO can develop comprehensive forecast models, KPI dashboards, and provide critical financial analyses that propel Amazon businesses toward sustainability. We also discuss the fundamental differences between accrual and cash basis accounting, why cash flow management is crucial, and strategies to enhance your financial health. Don’t miss out on these key takeaways that could transform your approach to financial management in your Amazon-selling journey!
In episode 400 of the AM/PM Podcast, Kevin and Jeff discuss:
00:00 – Importance of Knowing Your Numbers
03:21 – Corporate Finance to Fractional CFO
06:52 – Importance of Financial Management in Scaling
08:58 – Costing Mistakes Impacting Profit Margins
15:34 – Forecasting and Finance in Due Diligence
17:40 – Models and Metrics in Aggregators & Business Acquisition
19:44 – Financial Profile and Aggregator Capital
25:28 – Understanding Fractional CFO Services for E-Commerce
36:47 – Cash Flow and Accrual Accounting Insights
39:09 – Navigating Profit and Inventory Management
46:01 – Focus on Profit and Growth Strategy
49:09 – Navigating Financial Risks in E-Commerce
50:00 – Kevin King’s Words Of Wisdom
Transcript
Kevin King:
Hey, hey, welcome to episode 400, the big 400, the 4-0-0 of the AM/PM Podcast. My guest this week is Jeff Lowenstein. Jeff is a fractional CFO, was heavily involved in one of the big aggregators and evaluating businesses, so we talk everything about money in this episode, what you need to be doing to prepare yourself for an exit, what investors and aggregators and buyers are looking for, what are some of the things you can be doing right now to actually make your business much better and much stronger. It’s all right here and enjoy this episode with Jeff this week on the AM/PM Podcast. Look who it is. It’s Jeff Lowenstein. How are you doing, jeff?
Jeff:
Great to be here, Kevin. Thanks for having me on Doing well.
Kevin King:
I’m glad to have you here Now. This week’s topic might be it’s probably one of the most important ones that you actually need to know for the success or failure of your business. It’s not as sexy as talking about the coolest new TikTok shop thing or the coolest new marketing promotion, but, Jeff, when it comes to numbers and knowing your numbers, he’s one of the guys that knows his numbers backwards and forwards. Is that fair to say, Jeff?
Jeff:
Kevin, what could be sexier than knowing your numbers and focusing on profit right? Actually, pulling out a profit is about as sexy as it gets, I think.
Kevin King:
Actually I do. I mean because that’s why we’re all doing this right, it’s actually to make money, it’s not to boast about, show screenshots of, like look at my gross sales. I know a lot of people that have high gross sales but they don’t have two nickels to rub together. I know guys doing 10 million dollars a year on Amazon or in e-commerce and they can’t even pay their mortgage without something else going down the crapper. So I think your numbers it’s an important area, especially now in light of everything that’s happening with Amazon with all the additional fees, all the additional, you know, low inventory fees and return fees that are being instituted and all this stuff. I saw somewhere that the average sale on Amazon I think like three or four years ago, amazon was taking about a third roughly in fees and commissions and storage fees and everything. So, you could figure if I was selling a product for $100, amazon’s going to take about 33% of that to fulfill it and I could figure out okay, I’ve got another $20 or $30 maybe for my cost of goods sold and my overhead and maybe another third for my profit margin. That’s changed Now. Amazon’s taking upwards of 60, 60 to 65% of every sale, and so if you don’t know your numbers, you’re going to be SOL and probably be out of business soon. And with all these changes, I think a large number of unsophisticated sellers are going to be out of business if they don’t wake up and start paying attention. So, your background did you ever sell an e-commerce? Or what was your background before doing what you’re doing now?
Jeff:
Everything you just said resonates because I’ve seen those numbers myself firsthand as well. But to answer your question on background, no, I’ve never been a seller myself. I’ve been in corporate finance roles. My whole career started actually in Vegas at Caesars Entertainment doing corporate finance there. It’s a whole different animal, so sorry for another day. But then I got into e-commerce when I was working at Etsy over in Brooklyn. I was there on this strategic finance team it’s called, and so spent a few years there, learned the whole e-commerce world through that. From there, world through that from there I got an MBA and then most recently, was doing the aggregator thing, was an early employee, one of the aggregators and was on the M&A side. So met a ton of brands, saw their financials and learned that you know some of the finance skills I had built up over the years, the years from my earlier roles, could probably put to use as a service, and so that was the insight and inspiration to launch the Fractional CFO service to brands at large in the community. So yeah, so that’s my quick background.
Kevin King:
Your background was in corporate finance and then you just had this opportunity popped up and they said hey, we’re buying all these Amazon businesses. We need someone that knows some numbers to come in and evaluate them. So were you the guy you said you were an M&A? Were you the guy that was sitting down and going through their P&Ls and going through everything and asking all the questions and grilling them on everything? Was that you?
Jeff:
Yeah, that’s right. So it was a really cool job. I mean, I know a lot of people have a lot of opinions on aggregators and the crazy roller coaster that it’s been and what’s going on in the space, but for me personally, it was an amazing, amazing experience. I was at a company where I was the fifth employee. There was no infrastructure yet. We built everything from scratch. We went to a hundred million in sales over what two years? And there’s not a lot of opportunities like that you can get in any job really. So we were. Yeah, I mean, I was there on the front lines talking to sellers, interrogating them on their P&Ls, negotiating deals, and it really went from, you know, meeting the sellers and learning about their brands all the way through to closing the deal and integrating the business into the portfolio, and so, you know, leading that process, you’re still involved in the day to day and after we would buy the business still involved a bit, you know, after we started operating as well. So, it was an amazing crash course. You know like I said earlier, I never have started my own brand, but through that it was right into the deep end very quickly and I learned a ton.
Kevin King:
So, when these deals are coming to you, I guess the first step is someone’s there’s a business development guy or something analyze this looks like a good one. You go under LOI and that’s when you step in, right? And after it goes under LOI is when you step in, like to really look under the hood. How many times would you look under the hood and go, oh, my god, this looked good on the surface but, holy cow, this is a freaking show in here. Did that happen a lot?
Jeff:
Yeah, and it happened all the time, Kevin, and that’s part of the reason that I wanted to start a fractional CFO business was to help sellers understand their numbers. It hurt me. I saw these amazing, amazing entrepreneurs scale brands seven, eight figures. They had hit the mark on product, on marketing, they knew how to play the Amazon game, and yet they weren’t taking care of their books correctly, and so things that feel like an afterthought right, accounting feels like an afterthought. Having a budget and a forecast feels like an afterthought when you’re scaling, the day-to-day is so fast, right. You’re worried about your inventory getting in in time. You’re talking to people in China. You’re optimizing ad budgets. There’s so much to do. This whole finance function feels like it’s on the bottom of the list, right. And we would get to this point where, after years of hard work, the entrepreneurs scale this brand. It’s their life’s work and they’re ready to sell. And then we go in to analyze the financials and confirm that the numbers are what we think they are and what the seller thinks they are, and it’s really disappointing to learn that the books might have been done incorrectly and the profit is actually not what you thought it was, and that hurt me a lot on the inside to see that happen to people who had worked really, really hard to build their business.
Kevin King:
What are some of the common things you saw? What are just a few things that this was a repetitive pattern, that you saw that they not something as basic as cash versus accrual accounting or something, but something that you always saw. They just weren’t accounting for, they were just missing when they’re doing their numbers.
Jeff:
So cash versus accrual is a big one. But even within accrual accounting getting your COGS right is hard, and it’s just hard. There’s no way to get around it. To get the landed cost by product correct and make sure those fluctuations in the freight cost changes all the time. Your supplier might have moved the price on certain SKUs but not others. Getting that correct is really hard right, and so you may not notice trends. For example, your gross margin is compressing over time. It might be hard to see if you’re not doing things correctly.
Kevin King:
So when you say not doing things correctly, so you’re saying like, as an example, maybe when they started selling this product, the cost was $10 and their shipping was $2 and their taxes, whatever their landing cost was $14. So that’s what they were using as a basis in their cost of goods sold. But over time, because of COVID, the prices of shipping went from $2 a unit to $8 a unit. They were still showing it at the $14. They didn’t adjust it up and down, as it actually changed on a per shipment basis or monthly or as Amazon added additional fees. They weren’t accounting for all that, so it inflated the numbers.
Jeff:
Exactly right. That could be one thing. Another thing that happens a lot is not truing up inventory in the warehouse to what’s on the balance sheet. So some accountants will just draw down inventory on the balance sheet based on the COGS that you book in a month, but they don’t actually look at what’s left on hand in the warehouse.
Kevin King:
So, they don’t balance them, they don’t make them balanced.
Jeff:
Right and if you’re not tightly managing that and truing it up every month or even every quarter could be fine. You know you might get to the end of the year and realize you should have half a million in inventory in your warehouse, based on your calculations, but there’s only 200,000. Well, where did that extra 300,000 go? You’re going to have to, you know, do a write-off. You know you basically have a loss of value by that amount.
Kevin King:
When you were going to look at these, how did you actually analyze it? Did you just kind of lump it in and go this is all missing, this is not right deal over. Or did you actually try to break it down like, okay, wait a second, this $14, can you give me all your different invoices over the last six months? And you actually did the math and calculation, recalculated, or did you just look at it? I mean, how deep did you go? Or did you just look at it like no, this is not worth my time. This is clearly a mess.
Jeff:
It was a lot of work to get it right.
Kevin King:
Yeah, I was going to say that’s got to be a lot of freaking work, but as a result of that you’d learn a lot and you see a lot, like you said, you weren’t in this business, but you’d like, you see a lot and learned quite a bit from a wide variety of business. In a short amount of time. I would imagine.
Jeff:
You see quite a lot, right. So, for example to answer your question, how did we actually go back and analyze these things? Oftentimes we were rebuilding the financial statements from the source documents so we would get seller central access, Shopify access and rebuild it. You know ourselves not just take at face value the numbers we were given, and then, of course, that means also going into the invoices from the supplier like you mentioned and rebuilding those financial statements, which is quite a lot of work and you see some things. You see messy record keeping. Of course, you also might uncover things that are, you know, that weren’t advertised by doing it that way. Right, so you know there’s payments to certain vendors that may have been hidden from you, that are important part of the operating history of a business. That was something we certainly looked out for as well.
Kevin King:
Did you see, did you undercover any like hanky panky going on in there Like, oops, you actually can’t be showing this cost here as a expense. This is actually income to you or something, anything like, any kind of stuff like that ever reveal itself.
Jeff:
Yeah, I mean mostly what I’m referring to. Right, there is like for example, like using ranking services that may not be, you know, TOS compliant that were potentially hidden from us.
Kevin King:
How do you account for that? Is that a deal killer? Or is that like, okay, you know, we got to add that, take that out of the SDE, or add that back in, or account for this, like well, if they hadn’t used these ranking services and done it, TOS their sales would have been, I don’t know, 20% less. Or did you just let that slide, like okay, we understand that and we’ll just have to look at it a different way?
Jeff:
Yeah, it’s a case-by-case basis is the unsatisfying answer. You know, I think there’s also a certain trust element, right? If you’re buying this business from someone, you’re never going to uncover everything, and so you do want to be able to trust the person, and so when you do find something that was not disclosed or was hidden from you, that could be a red flag to say what else are they not telling us, right? So it was more about that. I mean, of course you know everyone used certain ranking services. You know, before Amazon started cracking down, Of course we understood that, and it was fine as long as it was. You know, either far enough in the past or you know the quantity was minimal enough, Right, so we were OK with some level there. But but you know, if it was, if it was a massive amount, that was that was hidden, right, that that would be a different story, Right?
Kevin King:
What percentage of ones that you dove deep into actually made the cut. Was it like 10%, 50%? What percentage actually ended up being acquired?
Jeff:
I don’t know the actual percent off hand. Our operating philosophy on the team there and I credit the management with this was they deliberately wanted to have a very high close rate compared to the other aggregators as a marketing tool.
Kevin King:
As a marketing tool.
Jeff:
We probably lost some deals because of this. But at the same time, when you’re working with brokers and sellers, you hopefully do get a reputation for saying you know you put out an LOI and you actually stand behind it. And so we probably missed some deals because other people were bidding higher and then probably knew they would cut that price along the way. We would only offer prices we knew we could stand behind and on businesses we really wanted to buy. So, we did have a higher close rate and, by the way, we probably did more work upfront than others who would just, you know, maybe put out a multiple based on what’s in the SIM or the deck that’s given out. So we did have a fairly high close rate, I would say, compared to others.
Kevin King:
How did you look at like, okay, I’m going to buy this company and the financials look good, but how were you projecting future opportunity? Were you taking the projections were you asking the seller like, can you give me some projections? Or are you going in like, okay, this looks good now, but let me see where this market demand is going. Let me go into Helium 10 or some other tool and check this out to see that, okay, if we buy this at 3x, we think you know it’s going to take us three years or five years to get our money back, but we can also grow it along the way if we can hit these targets and it looks like the market demand and the trends and whatever are going this. How did you do that analyzation?
Jeff:
Yeah, it’s a good question and this is what I do every day now as well. So certainly a big part of the due diligence process is the forecast right and the model you know. Part of it is the financing question of how are you going to acquire this using some equity and using some debt and make a return on that right. That’s important, an important question to answer and part of it is the operational forecast right. You’re actually going to take the reins and you have to operate this thing right and so, understanding over we would do like a five-year model. You know all the different drivers and all the different line items, from looking at revenue across different channels. You know, of course, Amazon would be important, but you know there could be direct as well as wholesale understanding the margins in those channels, as well as by product. Sometimes we’re forecasting by subscription versus not looking at all those things, and that skill and that process is what I’m doing today for brands that work with us as a fractional CFO as well. And so you actually asked do I take what they would give me at face value? And the answer is actually a lot of them would come to us without a budget or without a forecast at all, and so you know that was part of my insight as well is that for the first time, I was putting together a forecast for a very successful business, and that also hurt me as a finance person right, I love numbers. I couldn’t believe that there was no forecast before, so I’ve been doing it my whole career, and so that you know that that’s why I thought you know this the same work could be offered on a fractional basis as well.
Kevin King:
How did you account for like interest rates and stuff because you probably when you’re doing these a few years ago you didn’t know the interest rates are going to skyrocket like they have. How do you? Do you just put in a miscellaneous column of unforeseen or you know, a TikTok wasn’t blowing up like it was. Then those opportunities were that how do you account for that kind of stuff? Or you don’t. Those are just the unknowns that are just luck. Either good luck or bad luck.
Jeff:
This is what I say about that. Every model is wrong. Some are useful.
Kevin King:
But you have to have a target, a plan to shoot for right. If you don’t have that, you’re just flapping in the wind.
Jeff:
Exactly. Of course, like you know, we never could have predicted that TikTok shop would take off. You know a few years back, you’re never going to get it all right. You’re never going to optimize every single driver and input to get it perfect. And if you do get it perfect, you probably spent too much time on it anyways. The point of the model is to do the exercise and draw insights into the actions you should take, right? So you do the exercise, you keep it as simple and high level as possible and then you realize, okay, you know we should push more on. You know we can afford to go to a lower RoAS here for this set of products, right, and you go and do that. And you regroup and adjust the forecast and do the analysis and see where you’re at right. So, no, you’re never going to get it perfect. I mean, of course, interest rates and things like that. You do the best you can using the current knowledge that you do have.
Kevin King:
What was determining the multiple back then? Was it just something based on SDE, if it’s a product-based business, or based on a monthly recurring revenue, if it’s a SaaS, and what would decide? Or was it competition, like Thrasio is offering 3.5, so Boost is going to do 3.6. Or was it a combination of this forecast plus what they’re doing, plus what you could see like? Okay, we think what? What defines that model? And those numbers have come down now? Um, some of that was because competition and sometimes because changing cost of money and everything else. But what? What determined that number? So even today, someone is looking to sell. What’s going to impact those numbers the most or that multiple number?
Jeff:
yeah, I mean the unsatisfying thing is that there’s no simple answer or equation of it’s worth X based on ABC factors right, it’s a mix of quantitative and qualitative. You know, financial profile is important, course, meaning growth rate, different levels of margin, gross contribution margins and then, of course, your net profit. But things like category are important. How well do you compete with the other top products in that category? Do you have opportunities to bring this to other channels? And you would model it out? Hopefully you could. You could see a good return, only at certain price levels, right, and you’d figure that out and back into a price. And then, if then you go, you go play the game. You know the brokers telling you need to be half a turn above where you are and try to figure out if that can work in your model. Or maybe you pass, or maybe you play the game back and forth a bit, right. I mean, the interesting thing about the whole aggregator craze was it was a specific moment in time 2019, 2020, when I think Marketplace Pulse said $9 billion in aggregate capital had been raised, and that’s crazy to a space that had not really seen institutional capital like that before. Also, at the same time it was COVID, revenue was up, profits were up, and so there’s a lot of capital chasing a lot of profits that were I don’t want to call it fleeting in nature but were. There’s a moment in time right.
Kevin King:
And interest rates are near zero for access to that $9 billion.
Jeff:
Exactly and by the way, I think there’s an important thing that hasn’t at least I haven’t seen discussed that much is that a lot of the aggregators were funded as venture plays and not as private equity.
Kevin King:
What’s the difference there for people that don’t understand what’s the difference?
Jeff:
Private equity firms is typically buying more stable, mature business and they’re operating it for cash flow to see a return on their capital invested. They might be going, of course, on their capital invested. You know they might be going. Of course they’re going to try to grow the business as well, but you know they’re primarily financially motivated and so they’re going to buy at a multiple that makes sense for them to, you know, in three to five years, be able to return that capital to their LPs.
Kevin King:
So, they’re just looking for something that’s better than like if I can take my $100 million and I can put it into the stock market and get an average 8% return, but if I stick it into one of these businesses, I might get a 12% return. So therefore, I’m returning more to my participants in the fund.
Jeff:
Exactly, and for a private equity firm, I think they’re. I’m speaking out of hand or out of turn, but like 20% annual return is great right. For venture investors it’s not the case, right. It’s not the case that every investment needs to make a return. They’re going for big home runs.
Kevin King:
That’s that 1 in 500. That’s like I’m going to put a little bit of money in 500 different businesses. Say, I’ve got a million bucks, I’m going to put $2,000 in 500 different businesses and all I need is one of them to become the next Uber or the next Spotify or the next whatever. That’s more of a venture.
Jeff:
Right, they’re fine if 90% of their investments fail, as long as the few that do return money. Those winners are so large they make up for all those other losses, and so I think that contributed to this blitz scaling attitude where people were talking about it as a land grab and a winner-takes-all type market tight market where if you could show that you were growing the fastest and you were going to be one of the few winners in the space you know, it would all work out because you’d a be able to raise more funding and B there would be economies of scale and synergies to the largest winner.
Kevin King:
You’re saying that the 120 or 130 aggregators, a lot of them were venture based and they go. They went into it knowing that, hey, probably in three or four years from now, there’s only going to be 10 of us left anyway. We just hope that we’re one of the 10.
Jeff:
It’s not as simple as like. It was all funded by venture capital, right, I don’t want to say that there were private equity players in the space, but they did come in a little. The larger private equity firms came in a little bit later. If you look at the early funding in the space, it was a lot of venture debt and a lot of venture capital firms really seeding these businesses, and so I think that mentality caused the crazy run-up and the crazy amount of capital raised, which created a bidding war. Right, because if, all of a sudden, you’re backed by venture capital and you need to be the next Facebook to and that’s the goal you’re going to go crazy to make sure you get there. Right, because anything less than that is a failure. Right, and so that created these unsustainable bidding wars for some of these Amazon brands at a specific moment in time. It was what I call the blitz scaling mindset. Right, where, even if it wasn’t profitable in the short term, they were trying to play a longer term game that, by growing so fast, they would be able to reach escape velocity and be one of those big winners.
Kevin King:
I agree with you. That’s something that’s not really talked about at all. And just a reminder be sure you subscribe to my newsletter, billiondollarsellers.com. Billiondollarsellers.com totally free every Monday and Thursday with actionable tips. It’s like a $25,000 mastermind in an email. Hit that up. What is a fractional CFO? What does that mean?
Jeff:
So, we actually offer two different service lines. One is the CFO service, the other is accounting, and those are different in our minds. CFO services with us is there’s a few things. Right, the forecast model is super important and that looks out 24 months forecasting the P&L balance sheet and cash flow statements, with certain definitions of contribution margin. So that’s foundational. And then we set up a KPI dashboard so you can track everything month over month and see all the different metrics that you need to track. Of course, we do variance analysis, margin analysis. You know, trying to unpack the different dynamics. It’s hard sometimes when you have so many different. You know sales channels, products. You know you might be selling Walmart, amazon, amazon, different geos. A lot of those things get grouped together by your accountant and it’s hard to unpack. You know, am I making money in this segment of my business or not? Right? So that that’s part of the core work we do when we first start working with someone. Of course, you know we also work on raising debt. You know if you need to put in, you know a line of credit or something like that to fund your inventory. That’s part of a fractional CFO’s job, and all of that. Why are we fractional? It’s because you probably don’t need an expensive full-time CFO, but you do need a little bit of help when it comes to all this, right.
Kevin King:
What’s a full-time CFO typically cost for an e-commerce business? If I was going to hire someone full-time to come into my office and be on staff, or would I probably be paying?
Jeff:
It could be $200,000. It depends, of course, on the scale of the business that you’re at and the level of experience you need. That can fluctuate up and down, of course, but yeah. I mean, look, we see lots of e-com businesses all the time and so, in some regards, working with a fractional CFO could be a better experience, because a fractional CFO has insights across all the brands they work with that they can bring to you, versus if you had someone in-house, they’re only seeing your numbers day in and day out.
Kevin King:
So, the fractional one. So, it’s basically like a part-time. You’re working what 10, 20 hours a week, maybe, at most on someone’s business. I mean there’s going to be probably times where you got to do more than other times where it’s a lot less, but is that basically how it works, and so it’s just a flat fee, or is it an hourly fee? Or how does it work? Or is percentage of sales? Or how’s it works?
Jeff:
We do fix monthly retainers, so I’ll fix monthly retainers. Of course, we do more work some month and less the next. I mean, we don’t want to bill hourly because we don’t want to be incentivized to bill more hours. That’s not efficient for anyone and it works well this way. The cadence is monthly. We update the model monthly and in all the reporting monthly as well. The good thing about looking out 24 months every month is that you can see around corners right. So, you may not be thinking 24 months out. You may be thinking one, two, three months out typically, but especially if you’re a seasonal business, for example, and you’re growing in 18 months. I’m going to need that much in inventory before I can sell it, and seeing around corners like that is quite helpful as part of what we do.
Kevin King:
So, the CFO is mostly forward looking and the accounting is mostly backward looking.
Jeff:
It’s a very succinct and beautiful way to say it. Yes, that’s right, that’s right.
Kevin King:
So, when you’re seeing e-commerce people, what are some of the fundamental things they’re not doing? So, when you from your current clients that you’re working with, or maybe some experience you saw from when you’re analyzing the companies for the aggregator, what are some things that easy things, easy wins that they should just be doing? Besides, just get off Excel and get into a regular, into Xero or QuickBooks or something else. What are some easy wins for people listening that are doing $300,000, $500,000, a million? What should they be making sure they’re doing?
Jeff:
I think it starts with understanding your unit economics actually and there is a gut feel around what should my P&L look like? And doing the work to understand my AOV is this, my product cogs are this. My fulfillment is that my TACoS or marketing costs are something else. And understanding and getting a feel for what your P&L should look like and what those margins should be. And then when you actually go and do your books on an accrual basis, why are those margins not in line with what you thought that they should be? And really going and diving deeper into those is really like the core process that I would recommend people go through. The number one thing that people get screwed up on is getting the inventory on the balance sheet booked correctly and then getting that run through the P&L as COGS correctly and then recycling that process over and over. So I think having a clear understanding of the unit economics of those products, how much inventory you should have in the balance sheet whether it’s having a feel for your days of inventory on hand or what your gross margin should be is going to help you understand when there’s a problem and not letting it go. There’s a problem, you go, okay, whatever, I’ll figure it out next month. Right, stopping yourself and really digging in to say like this doesn’t feel right, why is super, super important?
Kevin King:
What’s a good margin that e-commerce sellers should be shooting for a good bottom line. So actually walk us through the different margins. You have gross, which is your gross sales. It’s everything your shipping plus the cost of the product, even plus taxes. In most cases that’s your gross top line. That’s what went into your bank account. And then, below that, what’s the next one down?
Jeff:
Yeah, this is probably a better answer to your last question. So, the way we structure the P&L is super important to us and you know it starts with the revenue. Then you have your gross margin, which takes out the product cost, then what we call variable order costs, which includes shipping and fulfillment, so the FBA fees, storage fees, etc. As well as merchant fees, so referral fee from Amazon, Shop Pay, whatever else.
Kevin King:
Credit card fees. All that. Are returns and allowances in that too?
Jeff:
Returns. I would take out between gross revenue to net revenue. So that’s important. So, after your variable costs you have what we call contribution before marketing, then all your marketing spends and then your contribution after marketing. And it’s a mouthful contribution before marketing, contribution after marketing. But I make myself say it every single time slowly, because it’s important to be super clear about exactly what it is, and so you know these numbers will fluctuate by category drastically, also by platform and by geography. But you know typically at the gross product margin. You know you’re looking at as high as, like, 85%, maybe for beauty and supplements, and then you might be as low as 65%, you know, for certain types of home goods, for example. So obviously that’s a huge range but that’s typically what we see. And then for the variable order costs, which then gets taken out before your contribution, before marketing, that could be anywhere from 20 to 50% right and of course on Amazon depends on your class, your weight and size of the products, and the referral fee also gets taken out there, right? So, again, that’s a range, but we look for that contribution before marketing. That should be hopefully around 50% or higher, which gives you 50% of your sale to spend on marketing and overhead. 50% is a good target, right? Not everyone is there, again, right. So, then you have your TACoS to take out and finally your overhead, right, and after all those things, if you’re still above zero, then you’re profitable. If you’re still above zero, then you’re profitable.
Kevin King:
If you’re still above zero at that final net. What’s ideal for an e-commerce business, especially if you want to sell it? Are they looking for typically like 20% or better?
Jeff:
20% is fantastic today. I think a few years ago 20% was more common to see. I think it’s harder and harder. As you know, you’ve had a lot of people on, I’m sure that have said about how much margins have been compressed between all the different Amazon fees. There’s a new fee coming out almost every day. It feels like the new low inventory fee is coming out. Marketing costs continue to rise, so that 20% felt like a really good threshold. If you’re at 20%, that was really good before. Now it feels like that’s fantastic.
Kevin King:
So more like 10%, 10% to 15% would be considered you’re doing on par average or something.
Jeff:
We see a lot of people in the 10% to 15% range. Yeah, that’s common
Kevin King:
Now is this after owner pay, or is the owner taking his pay out of that 10% or 15% or 20%?
Jeff:
Hopefully that’s after the owner’s pay.
Kevin King:
What do you see that most owners are paying themselves? Small, you know one, two, three person operations, not the big corporate people, but the average Amazon seller. What are they paying themselves on average? You know 2% of revenue, 5% of revenue. I know it’s going to vary, but if you just had to pick a number, someone’s listening to this, going what. What’s a fair number? If I’m doing a million bucks a year in gross with a 15% net, what’s a fair number to actually probably be paying myself?
Jeff:
The answer is it depends on your tax situation. I’m not a CPA. It depends on the specifics of your situation. We have some brands we work with where we partner with a CPA and they recommend to pay yourself as much as you can in W-2 income so you can pay no business or corporate income tax. And we have some that say the opposite, depending on the individual. So, there’s no one size fits all answer.
Kevin King:
And you said earlier something about accrual versus cash for the people that are accounting. What’s the difference in the two? Can you explain or give an example of how it might change a balance sheet or a P&L versus accrual versus cash accounting?
Jeff:
Yeah, for sure. So, cash accounting is exactly what it sounds like. You measure revenue and profits based on the cash coming in and out of the business, so it fluctuates, right as you. As you know, with inventory buys that’ll fluctuate. Accrual basis follows the principle it’s called the matching principle, which means that the costs are matched to the revenue in the period, and so that means when you sell a product today, you’re only recognizing the cost of that individual product rather than the actual cash inflow or outflow. So, cash basis accounting you see these really crazy spikes up and down in profitability because you purchase a bunch of inventories one month and your profit looks lower, and then the next few months you don’t purchase anything, and your profit looks lower. And then the next few months you don’t purchase anything, and your profit looks really high. On an accrual basis it’s much more normalized and steady because it’s the same percent should be the same percent of revenue in each period roughly. Does that answer the question how do you feel about doing the books now?
Kevin King:
I’m good. So, cash accounting would be like I spend $20,000 to my factory on December 13th, I’m taking the entire $20,000 as an expense or as a cost of goods sold right then on December 13th. Versus accrual would be if I pay him $20,000 on December 13th but I don’t actually get the shipment until January 30th and I start selling on Amazon on February 15th and in February I sold 20% of that inventory. I’m going to take 20% of the cost of goods and apply it to February and then drag the rest out. So, when I’m looking at my P&Ls and my balance sheet, it’s not going to necessarily show me cash. You know this is the cash. It’s not necessarily going to match. There’s a line on there for cash in the bank but it’s not going to match. Like you know, it’s not in my pocket, out of my pocket on the paper, but that’s where cash flow, which is another variable of this, comes in. And so, when investors are looking at businesses or stock people are looking at business, they look at what is the cash flow and they usually look for some sort of multiple percentage of actual cash flow. So, can you explain what cash flow is versus the accrual? And the cash-based accounting is the way you report it, but what is actually cash flow?
Jeff:
It’s such an important concept and earlier in my career I didn’t fully grasp this the way that I do now and the divergence between profits and cash flow are so pronounced in this space. If you’re an e-com seller, you chose a really hard space, hard business model when it comes to understanding the difference between profit and cash flow. Because we have inventory right. We have inventory that we haven’t sold, and so what do we do with that? We keep it on what’s called the balance sheet and that balance sheet records all the assets and liabilities you have. So, cash in the bank inventory on hand, any debt you might have or bills to vendors you might owe those would be liabilities. And so you have, on one hand, the balance sheet, which is assets and liabilities essentially, and then on the other hand, you have the profit and loss statement right, which measures business activity. Every month revenue minus all your costs, like we were talking about, you can be profitable for an entire year theoretically and have lost cash. Now how does that make sense? It’s because of all the inventory that you have to buy for next year. If you’re a growing brand without super high gross margin, a lot of your profits are going to have to be reinvested in inventory for the next period. If you’re seasonal as well, it’s even harder because you have peaks and valleys right. So, the profit on the P&L is not always equal to the actual cash that comes into your bank account. It’s actually quite different. It takes a while to fully grasp exactly the ebbs and flows of how to model that out and how to solve some of those gaps. That’s why when you hear people talk about raising a line of credit to help with inventory or there’s other types of inventory financing that’s what they’re trying to solve. How do we fund inventory for the next period, even when that requirement is greater than the profits I made in this period?
Kevin King:
So, what are some things you can do to impact cash flow? Is it better terms from your suppliers? Is it longer terms to pay? Is it less borrowing of money? Is it not ordering 5,000 units at time but ordering just in time inventory like 1,000, 1,000, 1,000? Is it deferring the way you pay employees or contractors, or something? What are some things that you can do to actually impact? What are some of the most impactful things you can do to affect your cash flow and make it better?
Jeff:
Yeah, great question. So, there’s a measure called cash conversion cycle which is important to understand, and that is a measure of how long it takes a unit of inventory, from when you purchase it, to convert back into cash in your bank account, and the way we look at that right, there’s basically three inputs. One is how many days of inventory you have on hand compared to your sales. Another is how many days of receivables you have. That comes into play in particular if you have a lot of wholesale relationships where they take a long time to pay you. Lesson still important, but less important for Shopify or Amazon. And then the last piece of that would be your days of payables, right, and that’s how long it takes you to pay your vendors after the bill comes in, right? So, looking at those three things together, you can get a sense for how much cash you have tied up on your balance sheet and how much is available to you or not. And so you have to look at each of those three things individually. Number one is inventory. Are you running lean or are you bloated. If you have more than 180 days of inventory on hand? That’s the cutoff where it’s probably too much. Anything about that. You know there should be a good reason why. Days payables is another one that people don’t always think about, but it’s super, super important. This is one of the best ways to decrease your cash conversion cycle, and so what that means is getting better terms with your suppliers. You can do things like just straight up negotiate. Of course, you can offer to pay slightly higher prices in exchange for more terms, for better terms, and you can also use certain financing tools. You know, and I know, amazon Lending just pulled their offering, but there’s a ton of other tools. I’m happy to help people think about which one could be right for them or make introductions as they need if they need to, but that’s another way to extend your payment terms.
Kevin King:
What do you think is the biggest thing that these Amazon sellers and e-commerce sellers are doing that puts their business at risk to fail? What’s the number one thing that they’re doing, that they’re just teetering on the edge here. What would that be when it comes to finances, overextending, overleveraging, is it too much inventory, like you said, sitting on too much slow-moving stock? What would be the one big thing? That’s just a killer.
Jeff:
All those things are important and it’s funny because I’ve thought about this a lot and I think that a lot of those things you just mentioned are actually symptoms of one underlying mindset problem, and the mindset problem is people want to grow too fast. The mindset problem is people want to grow too fast. If you’re growing your business too fast, you’re going to need to buy so much inventory to keep up. You’re going to need to hire people to keep up with the pace. On your team, you’re going to need to, you know, keep spending. You know, at a lower efficiency maybe, to keep up with the growth. And so, when you do all those things, if you have to get everything right for it to work Otherwise, it’s very easy to be off sides on one of those items you mentioned and all of a sudden, the whole thing can become at risk. Right, you might be growing really fast and that’s great. So, you invest in a really high-quality team. Could be good, but you have to keep that growth going. If the growth stops or goes the other way, you’re going to have way too much overhead and that’s not a fun place to be. You’re going to have to buy a ton of inventory to keep up with the growth, and if that stops or goes sideways, you’re going to be over-inventoried, and your cash will be tied up there. So I think that’s a problem. Growing at a steady pace is helpful. The cash flow needs, like we were just talking about, are more manageable at a steady pace. So some people can grow 100% year on year and that’s amazing. It’s really hard to say. Actually, I need to slow it down so I can keep up with this and make it more manageable. That’s what I would say. It’s really a mindset to be focused on profit and sustainable growth rather than just chasing as much revenue as you can.
Kevin King:
Do you believe that, as a business owner a small business owner you pay yourself first or you pay yourself last?
Jeff:
There’s a new trend called Profit First. Are you familiar with that one?
Kevin King:
I am.
Jeff
It’s a book. I’m not as familiar. I haven’t read it, but I know I’m familiar with the idea. I think it’s a good idea. I think constraining the business is important because I do think you are scrappier with less resources available to you. And by the way, the Amazon FBA community is extremely scrappy compared to the direct-to-consumer community, and I hope I’m not offending anyone by saying that. I see businesses in the Amazon FBA world with extremely lean overhead, whereas on the direct-to-consumer side not as much, and I always wonder why that is. Is it because the Amazon entrepreneur is more focused on profit and cash flow first. Or is it just because they’re scrappy or bunch? I don’t know. I don’t know exactly what the mindset is. Maybe you found that as well. I see you smiling, but I think the Amazon bunch pays themselves first and the direct-to-consumer crowd might pay themselves last.
Kevin King:
Yeah, I think you’re probably right. I always say that successful Amazon sellers like to work hard and play hard. And you see that sometimes when you go to these events or some of the ones that are traveling from, to all kinds of different events on what they’re spending on meals and parties and everything, it’s an interesting group, not, no, not me. I don’t. I never leave the house. I don’t do any of that kind of stuff. I watch every. I’m here. Coupon clipping. You know I can save 20 cents on the milk tomorrow.
Jeff:
You’re hanging out in your beautiful studio there.
Kevin King:
Yeah, exactly.
Jeff:
The walls are lined perfectly, the pictures are hanging perfect. I know there’s a lot of attention that went into that.
Kevin King:
I appreciate that. Well, Jeff, this has been great. This has been cool. If people want to know more or they’re interested in checking out the CFO services or something, what’s the best way for them to reach out or find out more about you guys?
Jeff:
You can check out our website free2growcfo.com. There’s a form there if you want to reach out. You can also just email me, jeff J-E-F-F at free2growcfocom.
Kevin King:
And what am I looking at? Like what’s you said it’s a monthly retainer. What’s a ballpark? Is it? It’s probably a range, but it starts x and goes up to x, or what am I looking at?
Jeff:
On the CFO side, the rates are around 5,000 to 7,500 a month, and then, on the accounting side, 1500 up to three or four thousand a month.
Kevin King:
Jeff, I appreciate man. Thanks for coming on the AMPM podcast. It’s been good.
Jeff:
Hey, Kevin, thank you so much for having me. This was really fun and great to get to know you a little better.
Kevin King:
There’s a lot of Amazon and e-commerce businesses that are at risk of going under this year if they don’t get a grip on their numbers. Just like Jeff was talking about, you’ve got to know your cash flow. You’ve got to know your numbers, and if you don’t, now is the time to do it, because it may be too late. If you don’t, you may be having high sales and a lot of money coming in and out of your bank account, but at the end of the day, what are you actually making? Are you just spinning the wheels on the hamster wheel? So, know your numbers. Just like Jeff said, hopefully you get some good insights from this episode. We’ll be back again next week with another awesome episode. I’ve got some words of wisdom, though for you to believe. The best way to get out of the hole is to quit digging in it. The best way to get out of the hole is to quit digging in it.
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