Manage Your Cash Flow after You Buy a Website
There is no magic formula to determine the necessary working capital for a website. Sure, every accounting-textbook provides a definition of working capital, but how does this translate into the virtual world? The bottom line is, working capital is the cash that you need to continue operating your website when your current expenses exceed the cash flowing in from Paypal or the credit card companies.
Working capital is critical to the survival of your website. Sadly, for most website entrepreneurs, it tends to take a back burner until it begins to cripple their website. Website owners contact me weekly requesting a simple formula to determine working capital. Unfortunately, working-capital requirements are different for every website.
In an attempt to provide some help to website owners, I offer the following observations.
Websites with a fast inventory turnover don't have huge working-capital requirements because the cash flows in from Paypal or other sources 24/7. This type of website might require 10% to 15% of its annual sales as working capital, as a rule of thumb.
Websites that sell a large variety of items require a larger working-capital cushion. A website that must maintain a large inventory, for instance, incurs high costs upfront for materials, but has to have the means to keep the servers up and running until it receives payment form the customers. It might be reasonable for a website such as this to keep at least 25% of annual sales as working capital, speaking generally.
The better a website owner manages working capital, the less he needs to borrow and depend upon lenders.
There are many examples of websites that did not manage their working capital. I know of one website that was booming and the owner had money in the bank. But it wasn't enough. The owner had decided to dramatically expand the services he offered through his website. The development of the much larger website was substantial. Meanwhile, there was the weekly payroll to cover, the monthly rent for the servers and other expenses. Moreover, as is typical with any website expansion, it takes some time for customers to learn that you are offering additional services. This means that there is some delay between spending the money for the expansion and receiving the money from the increased sales activities.
On theory, the website was doing great. But in reality, the website was running out of cash. The website owner had to borrow money at a high interest rate to keep going.
The type of a website you own will have an impact on working-capital requirements as well. Be careful if you operate a small B2B website. Many small B2B website owners dream of winning a big corporation as a steady customer. But invoices must find their way through the accounts-payable bureaucracy of those corporations, and most don't pay for 90 days. If you have a big corporation that buys goods or services from your website, it is worth your time to research the name of clerk who authorizes payments. Some website owners send gifts and other tokens of appreciation. It may sound silly, but these clerks can significantly impact your bottom line.
Big corporations have the means to address cash flow and working capital. An entire industry has grown around the issue of working capital management -- keeping tabs on the rate of inventory turnover, what raw supplies to order and what it means for cash flow. Small website owners must keep their eyes on the numbers. Always remember, cash is king.