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Return on Working Capital – Return on Podcast Ep. 38

Return on Working Capital - Return on Podcast Ep. 38

The following is a transcript of Episode 38 of Return on Podcast, the show where we help e-commerce sellers improve their ROI in business and in life. For more episodes, subscribe to our YouTube channel or listen on Podbean, Apple Podcasts, Spotify, and Amazon/Audible.

Tyler Jefcoat:
All right. Wow. Welcome to the final episode of the first season of Return on Podcast. My name is Tyler Jefcoat, and thank you so much for joining me for this journey. So after today’s episode, I’m gonna take a few weeks off to really get through the busy accounting season, and then I’m gonna gather some input from you guys and go ahead and launch season two.

So I hope you’ll hang around. I mentioned it in the last session, but do me a favor, go ahead and subscribe to this podcast or to the YouTube channel if that’s how you consume this content so that we don’t lose momentum and we can just grab you in a few months once we launch the next season. I do, I really value your input.

So if you wanna leave me some comments or email me, Tyler, t y l e r, Tyler@selleraccountant.com, you can get me directly. I’d love to get your input on what you’d like to hear us talk more about. Cash flow is one that I’m already getting a lot of pings about, so I’d love to hear what your cash flow challenges are so that I can craft that education content around what you need. If there’s any specific speakers you want to hear me interview, you know, let me know so I can really get those guys and gals on the show.

So this series that we’ve been in, this mini series, From Pain to Profit in 2023, has been amazing. And today, guys, is the culminating episode that I’ve been teasing it the whole time. This is the holy grail KPI that we have used to really differentiate Seller Accountant from all the other CFO shops in the country that serve e-commerce brands. This is what I use when I consult with private equity firms. This is what I use as a key leader for some of the investors that are out there, and it’s called Return on Working Capital.

And I wanna dive into how to use it, how to combine what we’ve learned through this entire series to really drive better performance for your brand. But I did just want to thank you. I just wanted to pause here at the beginning and thank you for consuming the content, and thanks for being a part of our Return on Podcast family. And I wanna offer you, if you do stick around to the end of this short episode, it’ll be another short one like these last few have been, I just wanna make a special offer, so hang around. I’ve got a, I’ve got a freebie I wanna give you at the end if you make it to the end.

But let’s let’s do it. This is what you’ve been waiting for, what in the world is Return on Working Capital? If you’ve heard me speak at any of the conferences over the last couple years, Prosper or some of the virtual conferences or some of the, maybe some of the regional ones that I’ve been at, you’ve probably seen a slide. Again, if you’re listening to this, don’t worry about it. I’m gonna try to really walk you through it carefully.

For those of you who are consuming this content on YouTube, you’re seeing on the screen now a slide that I’ve doctored a little bit, but this is kind of the, my standard slide. I use this on almost every presentation, and it illustrates the point of what ROWC or Return on Working Capital is. And by the way, that’s what we’re gonna do here. We’re gonna talk about what is Return on Working Capital, how do you measure it, how do you calculate it? What does it look like to have a good Return on Working Capital? Why do we care? And then I’m gonna give you some nuggets on how do improve your Return on Capital.

Just theoretically, let’s start before I start diving into numbers, like why do we care about Return on Working Capital? If you and I were to buy a piece of real estate, and we sold it and we made a million dollar profit, we wouldn’t know how happy we were, we wouldn’t know how much of a high five we need to give each other, unless we knew how much we had to invest, right? In any other investment in the world, we look at the ROI as being profit divided by what we have to put into it, what the inputs are to generate the profit. But for some reason in e-commerce, we ignore that.

We kind of look at profit in a vacuum. We ignore the inventory velocity part of the equation, and I think we do that to our peril. And so Return on Working Capital is my effort at trying to help us look at, on an annual basis, for every dollar that we beg, borrow, steal, invest into our business in the form of inventory, what is our annual return on that investment? Metric I made up was called Return on Working Capital. Let’s unpack it.

Again, if you’re watching this on YouTube I’m gonna walk through the example here. Try to make it palatable if you’re listening, but if it doesn’t make sense, go watch it on YouTube so you can capture this.

So I’m comparing two brands that have the same sales. They have the same 30% Cost of Goods Sold structure. They have similar Amazon fees and advertising costs, with the exception that one brand is a little better at this. The second brand, Brian, makes more money. His PAG, that post advertising gross profit for Brian is 30%, whereas for Amy, the first one, it’s only 20%.

So Brian is making more money, he is more profitable. His batting average, that return on inventory investment number that you and I looked at a few weeks ago is better for Brian, right? He’s generating $300,000 in profit, only took him $300,000 in Cost of Goods Sold. That’s a hundred percent return on investment. That’s amazing.

Amy’s ROI is a little bit lower. Her batting average is only 66%, that $200k divided by the $300k, but here’s the X factor. Brian is having to keep three times as much inventory in this business. The amount of money that Brian’s having to borrow, beg, borrow, steal, invest, put into his brand is three times as much as Amy’s.

And so the theory here is that even though Brian is more profitable, and he’s quite a bit more profitable, his business is less valuable because it requires a lot more cash input to generate that profit. And so I’m gonna encourage you to adopt a new metric. If you’ve never heard me talk before, you’ve probably never heard of this, but it’s called Return on Working Capital, and it is the way to take profit and inventory velocity and make them into one KPI. You can use this to manage your portfolio. You can use this to manage each of your ASINs or SKUs.

Here’s what the math looks like. If I take your profit for the year or actually let’s think about our last couple videos. We calculated in our session before last, our return on inventory investment, that’s our batting average. If we just multiply that batting average times the number of at bats we get per year, right? Last week’s session was on inventory returns per year. Amy gets three inventory turns per year times her batting average per turn of 66%, which yields her a Return on Working Capital of two for the year. That’s pretty good.

Brian, he has a really high batting average, but he only turns his inventory once a year. So that 100% batting average or return on inventory investment times the one turn per year gives him a one. So Brian’s Return on Working Capital is one. Amy’s annual return is two. Amy’s business is twice as good as Brian’s. Brian’s business is twice as risky as Amy’s, in spite of the fact that Brian has higher profit margins. And the reason, the X factor, the differentiator, is that Brian has very slow inventory velocity. He’s having to keep a year’s worth of Cost of Goods Sold on his balance sheet. Think about that. Think about how much of his cash is tied up in his supply chain.

I’m wondering, as you’re watching this or listening to this episode, how much of your cash is tied up in supply chain? The way you get punished if you have too much cash tied up in your supply chain is that even if your products are superior in terms of profitability, you may have a riskier, more stressful, more flimsy, less recession proof, less inflation proof business because you’ve got so much of your money and your capital tied up in inventory that you just have to borrow a ton of money. And so the thesis that Tyler is operating under, and I want you to start operating under, is that I’ve got to improve my Return on Working Capital.

Now we looked at the two variables in detail in the last couple of videos or our last couple of episodes, and the way I would coach Amy and Brian, again if you’re watching the screen here, is different.

Amy has pretty good inventory velocity. Eh, her profitability’s a little low, so if I was coaching her as a CFO, if I, and I was looking to improve her metrics even further, I would focus my energy on finding ways to improve my TACOS or if my product’s oversized and I could resize the packaging to get within standard freight for Amazon, maybe I would do that. Or if I could renegotiate my Cost of Goods Sold to lower what I’m paying my suppliers, right? Those are the kind of things I would tell Amy to do.

If I’m coaching, Brian’s already got pretty good, not industry leading, but pretty close to industry leading profitability, oh boy, his velocity is bad. And so for Brian, I’m gonna be looking at tactics to pull money outta the supply chain. And we talked about this in last week’s session, so let me just pull up that screen from last week so I can show you this again.

Again just a super quick recap. Return on Working Capital is, I’m gonna calculate my batting average, which is return on inventory investment. We did that two weeks ago, and I’m gonna multiply that batting average times the number of bats I get per year, which is how many inventory turns I get per year. And our example from the last couple weeks, that Return on Working Capital, is a little less than two. But then let me go down to the bottom of this screen cause I wanna show you. Here’s, if you’re looking to improve inventory performance and therefore your company’s performance, like I just told you, you gotta decide what my problem is.

If my problem is profitability, I’m gonna be looking at some of the tactics that I described in some of our profitability videos earlier in the series. Please go back and watch those. But things like raising your prices, negotiating lower Cost of Goods Sold numbers from your suppliers, doing better at managing my TACOS, having a lower advertising budget, that kind of thing.

If I determine that I really am in Brian’s situation where I actually need to improve my inventory velocity, then I want you to do the things I described in last week’s video, right? I gotta improve my vendor payment terms. Can I just pay you a month later? My goodness, if Brian could just pay his vendors on 30 day terms, it immediately improves his Return on Working Capital, and it improves it in a big way.

Another thing that Brian could do is he could kill his slow moving SKUs. Or remember last week I mentioned that like if you have the variant that never moves, the green one, no one ever buys the green one, kill it. Make the customer pick the red one. It’s okay. Sometimes you do a variant ’cause you think it’s gonna be a good idea and ends up just not being a good idea, not enough customers care. You could negotiate lower minimum order quantities from your suppliers.

Or the final thing I mentioned last week was just, improve the way you manage your inventory, right? If I have better visibility, better software, better processes, better people managing when I purchase, how often I can afford to wait to purchase, that kind of thing, then I’m gonna be able to improve that inventory velocity, which again means improving the number of turns, and that means I get to use that dollar more. I get more at bats per year. I don’t have to borrow it again ’cause I already have the dollar. I borrowed it the first time, and I can just redeploy that capital every time I get it back. I’m gonna redeploy it, get it and get another bat. I want another at bat, another at bat so that I get that batting average as many times as possible during the course of a year.

And so this is what I encourage you to do at the close of this series here, right? I want you to go and calculate your Return on Working Capital. You may have to go work through the other sessions to, to get the variables right, but Return on Working Capital, I want you to calculate it for your catalog, for the entire company, and I want you to calculate it for your hero SKUs, right?

Don’t, if you have a hundred different SKUs, you may not want to go do this for everything, but go to your top 10 or go to your 80% of your sales, whatever those SKUs are, and calculate the Return on Working Capital for those top 10 SKUs or for that top 80% of your sales, and try to identify: do I have anything that’s killing me? Do I think my biggest challenge is velocity, or do I think my biggest challenge is actually profitability? And then I want you to set goals. I want you to set specific execution targets for you and your team for the next three months, six months, to address whatever your concern is. And if you can get 5% better in whatever area you’re looking to get better in, you are gonna see massive improvements in your cash flow. You’re gonna see massive improvements in your profitability.

And so I promised at the beginning of this video, I’m gonna leave you with a, with an offer here, what I just described can be a little bit of a daunting task. But the basic core version of that assessment, I tend to charge starting a $300 up to several thousand dollars for me to go in and look at someone’s accounting and look at someone’s financial performance and give them kind of a diagnosis on that challenge, whether it’s more inventory velocity, or whether it’s more profitability. And so here’s the offer I’m gonna make you today.

For the first 10 listeners that email me, tyler@selleraccountant.com, put it in the show notes. First 10 people that email me, or you can go to the contact form on our website and you can get to me that way also. First 10 people that email me will get that assessment for free, no charge. Normally the basic minimum 45 minute version of it’s 300 bucks and they’re $3,000-$5,000 beyond that, and first 10 people that contact me, I will do that assessment for you.
Probably can’t do it on a SKU level in that intro call, but on a portfolio level and understanding what the health of your business is financially, I can guarantee you that I can add a ton of value and I won’t even charge you for it. So take me up on that offer. That’s my gift to you for listening to this entire season, this series. This has been a gift. Thank you. I love talking about this stuff.

And with that, I want to go ahead and close the mini-series, From Pain to Profit in 2023. I also want to close season one of Return on Podcast where we’ve been talking about these obsessions and habits, hacks of the most successful e-commerce entrepreneurs.

My sincere hope is that you’ve gleaned some nuggets that have served you in this series and in this season. I’d love to hear from you. I’ve had some feedback recently that’s really been encouraging and has helped me drive our next season that’ll launch here soon. But I’d love to hear from you. Any ideas you have, it will have an impact on how we communicate and what we do going forward.

And then again, for the first 10 listeners that email me asking for the freebie, I want the free assessment, Tyler, then I’ll, my team will follow up with you. We’ll book it, won’t charge you a dime for it, and I’ll help you unpack how you can improve your cash flow and your profitability going into the rest of this year.
Thanks again, guys. Have a fantastic 2023. Look forward to catching up with you soon.

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