Episode 42: Cash is King Listener QuestionsAugust 25, 2016 in Amazon, Ecom-Crew-Podcast, Ecommerce, Product Sourcing
On today’s episode we are going to answer some listener questions again. Today’s questions have to do with credit. You guys asked us, “How do I build business credit?” and “Why should I use credit vs. cash?”
We answer these questions today and give you some insight into how interest rates and loans work for businesses.
The points for “How do I build business credit?”
- Why it’s important to have good personal credit.
- Issues that can affect a bank loan.
- Why time changes credit negotiations.
- Why you need PayPal to do business overseas.
The points for “Why should I use credit vs. cash?”
- The benefits of credit.
- Credit as a tool.
- Cash as a tool.
- How to keep money in your company, while keeping up with inventory.
- How to build credit with vendors.
- Why you should only use credit for inventory.
- What are “net terms?”
Some of the other topics we discussed today:
- How to negotiate free shipping.
- Why you should always use cash if possible.
- What is the best percentage of interest?
- When to say no to the interest.
This turned out to be a pretty deep subject today. We’re glad we can offer some help or insight for you guys.
If you have any questions or anything you’d like us to discuss on the podcast please go to ecomcrew.com and fill out the contact form. Also we would really appreciate if you would leave us a review on iTunes. Thanks for listening!
Full Audio Transcript
Mike: This is Mike.
Grant: And this is Grant.
Mike: And welcome to this episode of the EcomCrew podcast. How’s it been going, Grant?
Grant: It’s been going pretty good. It’s 90 and hot in Seattle, so I wish I could sell some frozen yogurt.
Grant: Yeah, if it weren’t such a horrible industry. So how about yourself?
Mike: Yeah, things are going well. It was hot here for a couple days, but San Diego remembered it was San Diego, so it’s beautiful again. And yeah, besides that, I think we talked about it on the podcast at some point, we had s shipment show up that had mold in it that we’ve been dealing with that was fun to deal with. On top of that, I’ve been dealing with accounting, so those two things together make me a little cranky, but we’re on the tail end of that now and that’s definitely a good thing for me.
Grant: That sounds like leech in the eyeballs in more ways than one, so…
Mike: Yeah. And we got an industrial shrink wrap machine, so if you ever need anything re-shrink wrapped, I’m your man.
Grant: Gees, man. That sounds so sexy right now. Like the things that you really want once you get to ecommerce.
Mike: You know that you’re a stud when you’re looking for a 220 outlet.
Grant: Yeah, that’s so true. I was actually look at a bunch of auction sites for equipment for wood making, and I was like, “Oh, man, that C&C looks good. I could use that,” and then like, “Where the hell am I going to put it, Grant?” So I know the feeling.
Mike: Cool. So yeah, one of our most successful episodes has been the Cash is King I think is actually what we titled it. And we had a bunch of listener questions kind of come out of that, so we’re just going to spend today talking more about cash being king and just answering some questions that came in. So let me throw the first one at you, Grant, and we’ll just kind of kick it off from there and run back and forth through these. The first one is, “How do I build business credit?”
Grant: That’s always a great question, and for a lot of people starting a business, not everybody has a lot of cash available, so credit is really dependent on the person, and it sounds like the obvious answer, but the number one thing is just to have good personal credit. And a bank’s going to check you out and see what your personal FICO score and everything is, so your business credit is really going to depend on your personal credit. Wouldn’t you agree with that Mike?
Mike: That’s what I thought, honestly, to begin with because I have an 800-something credit score. It fluctuates between like 790 and 820, depending on the day. And I was like, “Oh, well, I’ll just go over to the bank that we’ve been working with for years and show them this and talk to them about it,” and while they were willing to give me a loan, it was $10,000, which is kind of like a laughable amount compared to our sales and what we’re doing. So I do think that you can get started with that but I was kind of disappointed with the amount that they were willing to give me just based on that.
Grant: Yeah. I think when I was thinking about business credit, and I do acknowledge that getting a loan from a bank these days is just like pulling teeth, but in terms of a business credit card, for example, I think it would be the difference between getting like a $2,000 everyday credit card. If you’re a living person, you’ll get probably $2,000 just because.
Grant: But if you actually have I think over – I mean I’m not an expert but I’d say over 650, you should get a $5,000 credit line. And at 700, 800, I’d be surprised if you don’t get $10,000 to $20,000. I mean I got a $20,000 line just from – I don’t know, I think my score was around 780, 800. I don’t really have revolving credit. But what did you get for your credit card?
Mike: Yeah, we have an $80,000 limit now on our Visa and we also have an Amex, which is basically an endless black hole I think. I mean I know that there’s a point where they would come back to you and say, “Hey, hey, wait a second. I need to make sure you can pay this.” But yeah, getting credit card debt has not been a problem. I was thinking more along the lines of a line of credit from a bank. But yeah, a credit card, no problem. Obviously, we personally have a really good credit score and a great history and I do agree that that is going to be kind of a one for one relationship to getting an initial business credit card. And then I do also think that time helps. Over time, I just keep going back to the bank and asking to increase the credit line. I do believe we started at $30,000 if I remember correctly but that was a while ago.
We both use the same credit card, by the way. We’re both using the Capital One Spark card, which I highly recommend. It’s 2% cashback on every charge, and I basically just try to shove everything into that. But I did recently get an American Express Gold card that does 3X points in one category and then 2X points in these other categories, and those categories are advertising and shipping is the other one. So we now have all of our shipping and advertising going through that, so we get 2X or 3X points to use for international first class tickets.
Grant: Did I tell you about that card? Because I have that same card right now.
Mike: Yeah, yeah. You’re definitely the one that turned me onto it and –
Mike: I mean it was one of the best things I think that we’ve done for our business. It’s actually a line item on our P&L, credit card cashback and it makes a big difference. I mean 2% on everything basically almost negates your credit card fee, or you can look at it as a discount for paying cash, and it’s stuff we’ll be talking about on this podcast. But yeah, we get 2% cashback on every transaction.
Grant: Yup, and before we were actually using the Plum card, which had kind of an interesting thing. I think it was 90 days interest-free, right? If I’m not mistaken. Or 1.5%. But it essentially can extend your terms out a very long time. And if you’re already on, say, net-30, net-60, even net-90 with a vendor and they let you pay through credit card, you can do an effective 100-day net maybe, which is kind of sick when you think about it.
Mike: Yeah. And the one thing we’ve been running into lately is, as our purchases get larger from vendors, there seems so be some threshold that every vendor has where they’re just like, “Look, we want you to pay cash or with a check or whatever now because we’re not going to take a $20,000 credit card charge and absorb the fee.” And my thing is, well, what’s the difference? If we’re placing a bigger order, why should we be penalized? So we usually end up having to go through some type of negotiation. But yeah, I mean it’s definitely good if you can get your vendors to take credit card. Unfortunately, when you call up a vendor in China and ask them to give your credit card number, they laugh at you, so that doesn’t work over there.
Grant: Yeah. If it’s under $2,000 a lot of the Chinese vendors do like PayPal because, at the end of the day, the wire fee for an international transfer versus the PayPal fee, which are pretty close I think, or comparable.
Grant: So, at some point, they’re just like, “You know what? I’m just going to do PayPal and do that.” But then again, you’re kind of losing if you’re doing it with PayPal anyway because you end up paying for it at the end of the day. And in terms of what you’re saying, Mike, with the vendors wanting to negotiate you off the credit card payments for their invoice, the reality is you kind of pay for it in the long run, so either you save by paying via a wire, or they just end up charging you a little bit more if you pay by credit card.
Mike: Yup, make sense. So the next question on here is, “Why should I use credit versus cash?” Do you want to take that one or do you want me to take it first?
Grant: Yeah, I’ll go ahead and bat on that one. So, this is kind of Finance 101, but we realize not everybody has been an ecommerce or just a business operator for a long time. But the title of the episode, Cash is King, really is trying to say that cash is going to be your life blood and your lifeline in everything that you do. Once you run out of cash, it’s not exactly game over, but your business is completely stalled. You can’t buy more inventory, you can’t hire more people, you can’t pay your bills; you’re just kind of in this still state. So credit gives you the ability to have a lot more potential on all of these fronts. It’s almost like a progressively good cycle. The more credit you get, the more you can pay it off ideally, then the more credit that will be extended to you. And so it’s very virtuous and you can do a lot more expansion for your business. What other things would you say credit’s good for, Mike?
Mike: I think it’s good to just grow your business at a faster rate than you can grow organically. A very smart guy, Bill D’Alessandro, who I’m good friends with from ECF, who went through some formal training on this and did M&A and stuff, has basically gotten my head around it in a way to think of it as like a tool and a war chest. I mean if you were trying to hammer a nail down, you’re going to pick out a hammer do it with. So I kind of think of credit that way these days, and the reason that I was so adverse about the credit thing is just because I’m adverse to any type of credit in my personal life. I mean we pay cash for everything. We put stuff on a credit card but I pay off the credit card balance every month. I don’t have a car payment. I do have a mortgage now because I was talked into getting a mortgage, but besides that I’m really not a credit guy. I mean I was that way as a kid. I think a lot of us go through that mistake, but having credit in an inventory-based business will allow you to grow more than 15% per year, which is all you’re ever going to be able to grow if you aren’t using credit.
Grant: I agree. The profit that you take from your normal sales, if you apply that profit into buying more inventory, that’s where Mike is coming up with that 15%. Let’s say you’re in a very, very profitable industry and you’re selling apparel where the cost of goods is very low and it’s a designer item and let’s say even if you take a net-30% at the end of the day, if you do $100,000 in sales, you’ve got 30% net, or $30,000, after you take that for yourself. Or let’s say you don’t take any of that for yourself. Now you can buy $30,000 in new product. So you could theoretically maybe buy enough product to double your business but most of the time, you’re going to be stuck at the profit margin. So credit enables you to keep running the business without having to yank money out of the business, and that’s almost like the thing that kills most people, which is not being able to sustain a business long enough without needed to grab money out of it. So you ever take money out of your business, Mike?
Mike: No. We started this thing back in January of 2015 after we sold Treadmill and since that time, we haven’t taken any money out of it, and it’s because we’re lucky enough that we have another source of income. If we didn’t, we would have to take money out. I meant he company does make money. I was just talking to Grant about some of our accounting before the show. We’re making what I consider to be really good money and we can certainly afford to pay ourselves a salary out of the business, but because we’re growing quicker than our cash flow is, we are a [probable? 11:46] company in the eyes of the IRS and we are a net cash flow negative company in the eyes of what is left in the bank account at the end of the month and the end of the year, and that’s because we’re buying inventory faster than the cash allows. So yeah, that’s kind of where we’re at.
Grant: Yeah. And it’s a crazy position to be in because I’m in the same position as Mike where, at the end of the year, I’m paying taxes on money that I’m not pulling in for myself. So, on the books. I’m profitable of course, and off the books, I’m just like shoving more money out of my bank account, which is a position that pretty much makes you feel horrible, but you know that you’re growing. And, for example, I’ve grown four times over my sales from last year and that’s just not a very great position to be in in terms of personal cash allocation, but credit enables you to start withstanding those kind of fluctuations, so the idea is that you can build more credit with your vendors. They have a history of you showing that you’ve done so much with them, and thus, you say, “Hey, I’m growing this much. You can see the rate at which I’m growing. Can you please extend me credit? Or more credit?” And more vendors are big enough that they’ll say, “Yeah, I see what you’re doing. I’ll give you more credit.” What’s kind of your negotiation with your vendors for credit, Mike?
Mike: We haven’t taken credit directly from a vendor really yet at all. We have one vendor that we have like net-15 with. I’ve taken a different approach. I mean I’ve use Amazon loans and I’ve used third party money for it. And basically, the way that I’ve approached it after talking to Bill and kind of getting my head around it is, first off, we only take credit for inventory. We don’t put computers or advertising or any of these types of things that then aren’t assets on credit. And I’ve taken it even a step further: I only put our own branded stuff on credit, which is the stuff that we have much higher margins for. So that’s been kind of the approach that I’ve taken. I do know that if I went to some of our vendors that we buy products from, that we could get credit from them and it may be something that we should do moving forward, although I’m more apt to want to do it with our Chinese vendors, again, where it’s on own branded products. But we get early pay discounts from our vendors that we’re buying other people’s products for and then we get the 2% discounts by throwing it on our credit card, and that’s just kind of the way that we’ve been handling it to this point.
Grant: Yeah. I’m in a little bit of a different boat I think, probably because I have a lot more domestic vendors on my side and I know with you, you’re doing a lot of larger orders so there’s probably not a lot of reason, if you’re doing a cash order for $200,000, to work on credit for another guy for a $5,000 order. It just doesn’t make sense. But for me, with my domestic suppliers, I would say 80% of them I’m on at least net-30 terms. A few of the really big guys like Unishippers, I’m on net-90 and that makes a huge amount of difference for me because shipping is 25% of my spend. So that’s essentially like my biggest vendor right there: shipping.
Grant: And so having a 90-day term on there, plus the additional 30 days for my credit card, I’m at an effective four-month turnaround. So it makes it a lot easier. It’s a lot more relaxing during the holidays because I’m spending just ungodly amounts of money on shipping, and this year, Jesus. I mean I expect to spend probably $60,000 to $70,000 a month on shipping at that time, which is the time that I need cash to keep my inventory flowing. It makes my life a lot easier that way. So that would be one of the things I think the difference between going domestic and international. But maybe you can explain at least the net terms to people that aren’t really familiar with them.
Mike: You’ll hear terms like net-15, net-30, net-60, net-90. Basically what that just means is that your bill is due in that many days from whatever line in the sand they deem it being, which is typically when it ships. So from the day it ships, you get 30 days to pay it, typically interest-free. So, you know, an interest-free loan for 30 days definitely helps because if you’ve got 30 days to pay for it, that gives time for the product to arrive and for you to sell through a portion of that to help pay that bill, or effectively it’s a 0% interest credit card for 30 days.
Grant: Now, what’s the longest net terms you’ve ever heard of?
Mike: I’ve heard of net-90, but it’s only been from us. We were looking at Bed, Bath & Beyond. They wanted net-90 days to pay us as a post-sale or whatever for our books. I was like, “Ah, that’s probably more than we’re willing to extend somebody.” But that’s the most that I’ve really heard of. I know that it exists out there for longer than that, but that’s the most I’ve heard of.
Grant: Yeah. I’ve heard the same thing from my uncle who’s doing the direct sales to Walmart and whatnot. They’ve got net-90 and I think they were apt to do net-120 and he just said, “Look, guys, like we’re not playing this game.” And it’s hard enough to get them to pay once that invoice is due anyways, so it’s one thing to be on net-90 and it’s one thing to be on net-90 when the guy has a problem paying on time. That said, what are the benefits? Because we’ve done a lot of work with vendors, at least in the very beginning, where we pay cash before we start getting into credit, and I know we’ve got some pretty good deals. Talk about maybe some of the deals we’ve been able to negotiate just by paying on cash though.
Mike: I mean we’ve gotten actually some pretty crazy deals. We have one company that gives us a 10% cash pay discount just for paying within 14 days. Like they basically have net-14 or whatever. we get a 10% cash pay discount and they let us use our credit card, which gives us another 2%. I think that’s the best thing that I’ve run across that I can think of, unless there’s something I’m not thinking of.
Grant: Yeah. No, I was going to mention with a lot of the vendors that we made vendors for us back at the Chicago show back when we were both working on CuttingBoard, I think most of the vendors we talked to were willing to do 10% as long as we paid upfront.
Grant: And even free shipping if we made it like a $2,000 order.
Grant: And I get the feeling that most of them, above $2,500, you get some kind of bonus no matter what. But just being upfront and paying by cash, yeah like 10% seems to be a fairly reasonable number and –
Mike: Yeah, and just real quick, we have gotten free shipping over a certain threshold just from pretty much every vendor because there’s one or two that doesn’t want to do it. But basically we just go to them and say, “Look, what would it take to get free shipping?” So you figure out a number that’s like a pie in the sky number, because when we were first getting started with them, we knew that we were going to quadruple or even more our account just because we were taking it over and knew what we were going to be doing with it. So their pie in the sky number would be like, “Oh, well if you spend $2,000 at a time, or even $5,000 at a time or whatever,” and I’m like, “Sure. No problem,” because like I know that shipping could be 10% of the order, so that’s basically a 10% discount right there.
Grant: Yeah. And this is really, I think, the crux of it because when anybody else asks us like, “Grant and Mike, why don’t you guys use credit more?” I would say credit is great if you don’t have cash, and even when you do have cash, credit is great. Don’t get me wrong. It’s great to have credit. But if you’re not in a position where you need to utilize your credit and you’re still growing at a point where you still have cash, having that cash not allocated, it’s better to have that cash put out and get a great discount, such as 10% on your cost of goods as opposed to not getting a discount on your cost of goods, because at that point, your headwind and your hurdle rate like change drastically because, on one perspective, if you have a 10% interest, which I think is low – Mike can probably talk about what are some reasonable interest rates afterward. But if you have a 10% headwind and your cost of goods is 50%, let’s say, now your actual cost of goods is 60% after you take into account your interest and how long it takes for you to pay it off and whatnot.
But, if you actually have a discount of 10% by paying cash upfront, now your cost of goods is only 40%. So it affects your ROI a little bit differently and you should really be thinking about things and how much you can get your cash into more cash at the end of the day, and that’s what I mean by ROI. And I’m kind of hitting multiple points here, so I might just pass it back onto Mike, but the idea is that this is, again, why cash is king because you can dictate how you’re going to use your cash most effectively. Like Mike said, it’s a tool. So maybe, Mike, you can talk about this because I know you’re done a lot of various looking at different large loans. What do you think is a good percentage?
Mike: I think the best percentage you’re going to find out there is 15%. That’s really the bottom line if you’re not going through a bank and you’re not using like a credit card, if you’re just taking a line of credit from one of these things like Kabbage or RapidAdvance. There’s a ton of them out there. Amazon obviously does it, PayPal Working Capital. All of them pretty much bottom out at 15%, which is obviously high. Again, that’s taken me along time to get my head around because for me to pay 15% interest is just so counterintuitive to like how I run my life over the last 10 years. But again, if I can get a half a million dollar line of credit, let’s say, and put all that into inventory, it’ll allow me to grow my business 4X next year versus 15% next year.
So 15% growth versus 400% growth. It’s like, “Well, which way am I going to go?” And we’ve chosen to be more aggressive and take the line of credit, and again, the line of credit is on assets that are not appreciable assets, but they’re not depreciating assets. We’re buying inventory, we’re making smart decisions and buying stuff that’s going to sell relatively quickly at very high margins, like way higher than the margins that we’ve been doing at [Keystone? 22:11] pricing. So I think that that’s the bottom line number you’re going to find out there. What I do encourage you to think about is to stay away from ones that are way higher. I’ve looked at several of them that were like 30%, 50%, 60%. Like I don’t even know how they can offer –
Grant: Oh, God.
Mike: How they can even get away with it. It’s like loan shark rates, right?
Mike: Yeah. Yeah, and it really pisses me off like more than anything else because I tell them upfront like, “I’m not going to pay you more than 15% interest,” and I went through like a dozen of these things. I actually had a partner of mine help me with it just because I hate filling out paperwork and dealing with it. And we would just tell them right upfront like, “We’re not going to pay more than 15%,” and just like any other salesman: “Yeah, yeah, yeah. No problem. It won’t be any problem. Fill out the paperwork, we’ll get it back to you, blah, blah, blah.” And they come back with like a 30% or 40% rate and you’re just like, “Why did you waste my time? It’s just not going to happen.” So the things that we’ve been able to get the actual 15% rate on have been Amazon, PayPal Working Capital, and Kabbage. Everything else has been higher than that so…
Grant: Yeah. And I’m going to add in here one of the reasons it can be so low on PayPal and Amazon is because they actually have information as to your actual sales, whereas a bank is still relying on your numbers. You know, they’ll still go and look at your merchant sheet and say, “Okay I see you’ve done this amount of transactions.” The idea’s that Amazon knows you’re buying inventory. PayPal generally knows you’re buying inventory and that these are based on actual transactions, and they can see your sales velocity, which is very, very important.
Grant: And I think they honestly are just a lot smarter than the banks. Not to insult bankers, but modern banking is not made by the retail sector or even the business loan sector. Modern banking is made by having hedge funds trade your money for derivatives on the open market. So most of them don’t even make any money off loans these days. It’s kind of a sad situation, but I’ll end my little political rant there. The whole idea is just that banks don’t really care that much anymore about your money, as much as you would hope that they do. So Amazon and PayPal, they know your business better than the banks will ever know your business and they’ll loan you money.
Grant: On the other side, this is why I say going with vendors is a very good option, because vendors know your business too. Especially if you start out small and you show great growth, consistent growth, they will be very, very open to giving you credit, at least in my experience. Net-30 is almost like a given. A lot of vendors will just establish you with $1,000 or $2,000 off the bat if you can show that you’ve got like a credit rating via a DUNS number or any kind of other revolving credit, or a credit reference check if you’ve got other vendors that do have credit. So –
Grant: Do you use DUNS at all, Mike?
Mike: No. We’ve been bad about that. I mean it’s something that I know is important. We just haven’t done it because we’ve been able to get the credit that we need to this point, but it’s been kind of a crash course this year in credit and then going to a bank and being told no, and knowing that there’re better rates out there, I mean that was what frustrated me to begin with. It was like, “Well, I’m not going to pay 15%.” I know that banks will give you a lower line of credit, but the reality is that no bank is going to work with you until you have two full years of business completed with a positive cash flow, or not cash flow but a P&L that’s showing a profit. It should say each of the first two years, and then file your tax return at that point. So we’re not at that point yet. Last year was our first full year of business. Unfortunately, it wasn’t a complete year; we started in like February. So I’m hoping that they’ll give us a grace for that, but luckily we turned a profit in our first year. And this year, we’re going to show a huge profit and I’m hoping that in 2017 we’ll be able to get a bank loan at a much better rate.
Grant: Yeah. I really hear you about the banks and that’s why I’m just not a fan of them either. For those of you who don’t know, I actually own two franchises as well, in addition to the ecommerce business, and I was running those before ecommerce and we’ve been in two mall locations for a while and we have a very stable business. I mean franchises are really the definition of a stable business in my book. I mean they have a lot of marketing behind them, they have a leased location. It really doesn’t change a lot; you just have a standard procedural business model, and even then, we’re doing over $1 million in sales, and we go to the bank and say, “Hey, we want to borrow some money to open another store,” and then it’s like, “Oh. Well… no.” I mean they go, “How much money do you generate?” “This amount.” “Okay. What’s your profit?” “This amount.” And everything is very healthy and they go, “Well…”
We went through about four to five different banks. They say, “We’ll offer you something that’s some stupid interest rate, like 20% or 25%,” and I just say, “Why would I do that? Why would I pay you 20% so that I can run this store?” And again, there’re some math reasons why it might be good if I was lacking in money because if I can only put 20% down, then my ROI is still going to be higher than if I did the cash, but the idea of paying somebody 20% to run it just infuriates me in some ways. But maybe we can walk through the math with some people of why sometimes it’s good to take an interest rate and why sometimes it’s bad.
Mike: Yeah. I mean we could put together a spreadsheet and link it up in the show notes or something. But I really think that 15% is really kind of the maximum you should be looking at. Maybe it’s 20%. I don’t know. I hate paying interest so I’m just like an anti-interest guy. As you said, I mean if you end up with like $100,000 line of credit, it’s $15,000 a year in interest, it’s something like $1,200 a month or whatever that works out to. It’s a pretty substantial expense and you have to be able to overcome that headwind of the interest payment and those additional profits that you’re borrowing the money for to make it make sense. And for us, I’ve done that math and it definitely makes sense. Like it makes really good sense and we’re going to be able to grow our business, like I said, about 400% over the next year with that line of credit. So I guess that’s when it makes sense. If you have a product that you know is selling really well and you want to expand your business by a substantial amount, you know, a 20% or 25% interest rate I guess could make sense. But it’s scary to me. I always like to have a way out so –
Mike: The lower, the better obviously.
Grant: Yeah. I think what interest rate really comes down to is what your net profit is, what your gross profit is on a product as it pertains to ecommerce, and interest really forces you to have a higher profit item. And if you’re in an industry where you have a low margin item, interest can be very scary because it ties your hands down and it reduces the amount of profit that you can take. Me and Mike were talking beforehand about a business model, for example, that it doesn’t really matter. It would be drop-shipping. For drop-shippers, you don’t have to carry inventory so you have no cash outlay. That’s why it’s been such a profitable and well-received model because when you drop-ship, you don’t have any carry cost whatsoever, you don’t need to worry about interest. You simply sell for whatever price you want and take the profit right off the bat. You get paid before you actually have the expense, which is always like a nice position to be in. So, if anything, you’re at like a negative cash situation because you get paid first.
And with drop-shipping, unfortunately, what that also means is that it’s super competitive on pricing because if you don’t ever have to worry about a carry cost, then you can essentially say, “Well, maybe my cost of goods is $1,000,” whereas somebody else will have to at least charge $1,500 or maybe $2,000 for it. You can charge $1,1000. You’re not including shipping over here, but if you make $100 profit or gross profit off a $1,000 cost of goods item, you’re still profitable because the cash flow doesn’t really matter to you. At the same point, every other person out there drop-shipping the same item is going to think along the same business model. So, in some ways, I would say holding inventory is really your defense against drop-shippers in certain business models. Would you agree, Mike?
Mike: Yeah. Definitely. A better way to put this as far as what’s a good time to pay interest and what rate can you pay: the amount that we basically did, just to kind of fill everybody in, let’s just use the $100,000 number again. If we get a $100,00 line of credit and bring in inventory – and this will also tie into another question we had here, which was, “How much ROI should I be making?” and we’ll use this to kind of wrap up the show. So we target 100% ROI, but like absolute bottom line is 70% ROI, and that’s after all fees and only when selling on Amazon. So let’s use a 100% ROI number as an example. We would take our $100,000 line of credit and turn that inventory let’s say twice in the first year so the first year you’re putting deposits down and waiting for things to come in and getting things ramped up. So the first time we turn the inventory, we would be at $200,000. The second time we turn the inventory, we’d be at $400,000. If we’re paying interest on the initial $100,000 loan of 15%, we’re paying $15,000 to make $300,000. And that’s where it becomes like a no-brainer for me. I think that makes sense. Did I kind of explain that right, Grant?
Grant: Yeah, I think so.
Mike: So I mean those are the reasons why we’ve kind of gone out on a limb and taken that chance. We’ve also put in a lot of our own money to start with and I was kind of cocky about it to start with. I was like, “Oh, I’ve got plenty of my own money. I’ll just put it all in as cash and buy stuff as cash,” but what ends up happening in an inventory-based business, as you grow at the rate that we have and you’re doing millions of dollars in sales, unless you’re incredibly independently wealthy and you have your money also very liquid, it’s all of a sudden, you have a very little amount of money, which is the situation that we find ourselves in, not because we’re on a balance sheet or on a net worth position where we’re doing great for ourselves, but then as a liquid position, it’s very difficult because inventory requires so much darn money.
Grant: Yup. And it’s one of those where you’re almost being – I wouldn’t say penalized is the right word but you’re being handcuffed by your own growth. And if you don’t have your credit in the correct situation, then you will simply have a limitation on how much you can grow. Yeah, I mean it’s just you have a finite amount of resources with credit and cash, and more people don’t realize that until you’re out of credit or cash, which is like a horrible situation to be out of cash. So –
Mike: Yup. We’ve been working really hard to make sure we don’t end up in that situation. I have nightmares about it as it is. I just was talking about it with my mastermind just doing some basic exercises. It was interesting. We put together a spreadsheet just planning out how long it takes to get a product cash flow positive, and it turns out it’s about eight months from the day that you’re starting out with it, which is a long time, you know. It was after the second inventory turn that we were able to start climbing out of the hole. So just kind of planning for that stuff and then making sure that you have sound margins, which again, I was mentioning to kind of wrap up the show here. I’ll spend a minute or two on this, Grant. What do you target for an ROI?
Grant: I would say in terms of – because I operate like you right now, mostly in cash, so the type of KPIs and metrics that I use are generally my net on sale. So I mean I’m targeting like a 15% net for sale, so the reality is that my ROI is somewhere close to for every $100 that I outlay, I want to be netting $15 at the end of it. But when you put it in terms of my cost of goods and everything, my ROI should be quite high, the total amount probably around 30% to 35% out there in terms of return, but that’s if you’re talking about net.
Mike: Yeah, we target way higher numbers than that and that’s why we’ve been pushing more and more towards doing private label stuff or having our own branded stuff. I mean we’re looking at an ROI – and ROI, just so everybody knows, is return on investment, so look at the, to use Grant’s example, $100 investment that we’d make into inventory. After we’ve sold that inventory and paid all the fees, I want another $100 back, so $200 at the end of the day, basically double out money. Now, obviously, there are other expenses like rent and employees and all those other things that come out, but looking at it in a pure gross profit mode just selling stuff on Amazon, when we buy $100 worth of inventory, after paying Amazon, paying brokerage fees to get them in here and landed and then get it into Amazon and after Amazon takes their 15% and ships it and does all that other junk, the absolute minimum we target is 70%, but we try to be at the 100% range.
And we’ve been operating in a net/net profit, as a company, as 15% right now, but that margin’s been increasing because we’ve been getting more and more away from existing products that someone else is selling and doing out own branded products, which have much better margins. So I expect our margin to be, this time next year, closer to 25% net margin. So if we sell $100,000 worth of product, we make a $25,000 profit at the end of the day after paying all salaries and all expenses. Does that all make sense, Grant?
Grant: Yeah. And I was going to add just one thing. I know we’re pushing our time as usual over here, but I just want to do one quick example for everybody because I know some people are probably going to have a little bit of a hard time keeping up here. But one of the things I did as part of my investment group before we got into franchising was we looked at commercial properties, which is a very easy concept to kind of get your head around. But just to use like a very round number, let’s say there’s a $100,000 property that you’re looking to buy. Let’s just say it’s a parking lot and let’s say this parking lot, every year, if you owned it outright in cash, could generate your $20,000 net. Now, if it takes you a 20% down payment to buy this property that then nets you $20,000, you know, that’s theoretically, on paper, 100% ROI. So that’s talking about, “I only put down $20,000 to make $20,000.” Now that’s where interest comes in and plays a little bit because if you have a 100% ROI, 20% interest isn’t so bad on that because you only put 20% down and you’re paying this amount.
So at the end of the day, within X amount of years, you have it paid off and everything. Now, the problem is interest rates are usually pretty aggressive, depending on where you’re going. And to be able to net 20% on a property, usually you’re paying a lot of headwind into the interest rate, so a lot of people on commercial properties these days are generally breaking even after you take in the interest rate that you’re paying and then combining it with all your overhead. So the whole idea is that with a little bit of money, the idea is to get your interest rate to the point where you can take cash after you’ve paid your interest and, even more ideally, to pay yourself so that you can actually do something with that. But the more that you pay yourself, the more interest that you’re paying, the more that you’re kind of acting as a headwind to yourself. So the whole idea is to hold your breath as much as you can and keep running until you finally have to pay yourself, if possible. So I don’t know if that example helped at all.
Mike: Yeah. Makes sense. So I think that’s probably a good place to stop it here because we’re kind of butting up against our time. If you guys have any other listener questions, please send them in. Again, we love listener questions. We actually have some more here from this episode. We might have to make a part three of this at some point in the future because it seems to be a big topic for everybody and I can certainly understand why. So if you’ve got time, please leave us a review on iTunes. If you’ve got time as well, shoot us a listener question. Just go over to EcomCrew, hit the Contact form, and send up listener questions. We love answering them on the air. Besides that, Grant, have a great week, and all of our listeners out there, have a great week and we’ll see you next week.
Grant: All right. Take care, everybody.
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