How To Optimize Your Supply Chain to Extend Your Cash Flow Runway?

Lengthening your runway is a function of reducing your burn rate, but reducing burn is not the same as reducing cost. 

As Matt explains, “It’s important for a startup to recognize that your problem isn’t necessarily profitability, it’s cash flow. Improving your cash flow could mean reducing expenses which improve profitability as a side effect, but there may be other tradeoffs you could make that could improve your cash position.”

Aaron adds, “In most startups, your supply chain is usually one of the biggest consumers of cash and understanding those tradeoffs can be the difference between making it through a rough patch or not.” 

Lever 1: Understand the importance of Inventory Levels 

One of the single biggest uses of cash for most startups is inventory. Obviously, you need enough in order to sell and manage any variability in demand, but holding too much or holding inventory for a long time ties up cash that you could be using for other things. 

“Inventory is cash in illiquid form and businesses should view inventory as an insurance policy against the unexpected.” 

Aaron continues, “The longer and more complex your supply chain is, the more opportunities there are for things to go wrong that you need to self insure against with inventory.” 

One of the most effective, and easiest ways to improve your cash position is to lower your target inventory levels, liquidate excess inventory, or temporarily discontinue slower-moving SKUs.

Lever 2: Understand the importance of Payment Terms

“Very few of the companies we first meet truly understand the power that payment terms can be in a negotiation,” states Aaron. 

Payment terms, when and how you pay your vendors, can be a huge factor in determining the state of cash flow in your business. 

“There is an enormous difference between putting 50% down on order and the balance on shipment and Net 15. Payment terms are typically the cheapest form of debt.”, adds Matt.

Effectively understanding your cash cycles is also extremely important as you prepare for a fundraise. 

Aaron states, “If you play things right and run a tight ship from an inventory perspective, you can actually leverage your supplier’s balance sheet to scale your business. Even if it costs you a reduced margin in the short term, having extraordinary payment terms can help you scale faster than you’d normally be able to and comes with an easy margin improvement story when you decide to reduce your terms later on.”

Make-to-order mattress companies are a fantastic example of a positive cash cycle. In most cases, the consumer places the order online before the company places the order with the factory. 

The mattress is then made to order and shipped to the customer. The Brand gets paid 1-2 days after the sale and they usually don’t pay the factory until 30 days after it ships which means that the Brand is sitting on all of that cash before they need to pay their bills. 

Compare that with a traditional retail channel where the Brand is asked to sit on 6 weeks of finished good inventory as a buffer for the retailer who then pays 60 days after they receive the goods. 

In this case, the Brand probably has a negative cash cycle between when they have to pay their factory and when they get paid themselves. Payment terms are especially important to consider as you prepare to launch into retail.

Suppliers will charge you more for extended payment terms, but in many cases, it’s worth the trade. “I’ve actually encouraged startups to trade significant margin for net 180-day terms because it was the right thing to do for their business,” states Aaron 

Fortune 500 CPGs like Unilever and Procter & Gamble are prime examples of companies that effectively manage payment terms. 

These companies negotiate terms that dictate a 90-day payment period with their supplier and only a Net 10 or Net 15 payment term with their buyers. 

This means that a CPG like Unilever holds weeks’ worth of inventory without paying for it, sells it to stores and gets the cash well before actually paying their supplier.

Of course, not all startups will be in a position to fully leverage payment terms with existing players but it should still be a priority as you set up your supply chain.

Lever 3: Understand the role of Financing

Not all the money that’s coming into your business needs to be equity. Several financing options exist that can help businesses extend their runway. 

If you have unfavorable payment terms (or even if you don’t) there are other intermediaries out there that will help you extend your payment terms. 

As an example, if you have Net 30 terms with your factory, you may be able to extend your terms to Net 90 for a reasonable fee. 

Debt usually needs some kind of collateral to borrow against. This could be your inventory, your accounts receivable, your factory equipment, or a personal guarantee.  

These companies can also securitize your inventory, meaning that upon payment failure, they’ll own your inventory. Similarly, there are companies that can do accounts receivable factoring (also known as factoring).

Debt doesn’t have to be a scary thing. If you use it correctly it can be a helpful tool to grow your business. 

Matt explains, “The key thing to keep in mind is that when you borrow money you have to think of the interest you’d pay as the cost to buy the money. As long as you’re spending it on things that will generate greater future returns in the future, you’ll be ok.” 

Lever 4: Move your Supply Chain closer to your Customer

“90% of the benefits or headaches you’ll have in your supply chain come from how you design it.” 

Aaron continues, “If I’m planning what I want to eat for dinner tomorrow, I’d approach things very differently if I knew I had a taco stand around the corner that was going to be open versus if I was planning on going on a 7-day backpacking trip on my own.”

If your main factories are in Asia and you’re shipping to North America, your shipping lead times alone will dictate that you hold 45-60 days’ worth of inventory at a minimum to account for port delays, lead times, responsiveness, etc. 

What if you were to shorten your supply chain?

If you move your production to North America, your responsiveness increases and you’d be able to hold less inventory which equates to less cash. 

Not everyone may be able to move their factories to their local markets. 

In such cases, startups can look at changing their terms with their factories to take possession of inventory at the destination versus at the origin and basically mimic having your factory domestic with a near-shore warehouse that you draw down from. 

The trade-off here for cash is reduced control and insight into your supply chain. Aaron counsels, “Sometimes it makes sense, but just make sure you are fully aware of the potential issues before making that trade.”