"Cash is king" is the wrong lesson for online sellers

An online seller can have money landing in the bank every week and still be heading for bankruptcy. I see it far too often, and it usually starts with three words: cash is king.

The phrase is not wrong. Profit is no good without cash flow, and a business that makes money on paper but cannot pay its suppliers can still fail. But many online sellers have taken the lesson the wrong way round. They watch the money coming in and assume that if cash is flowing, the business must be working. Plenty who think that way are not making a profit at all.

Why turnover hides the truth

Selling on Amazon, eBay, Etsy or Shopify produces a lot of movement. Payouts arrive regularly. Stock is bought and sold all the time. The bank balance rises and falls so often that it never settles long enough to tell you anything.

Constant cash coming in feels like success. It is not the same thing. A seller can turn over a large sum and keep very little of it once stock, platform fees, advertising, postage, returns and tax are paid. What you sold is the vanity figure. What you kept is the one that matters, and only a proper set of accounts shows it. The payout report does not.

How the spiral works

Most of the businesses we look after sell online, so I see the same pattern again and again. The business is not profitable, but cash keeps moving, so the owner does not notice. The shortfall goes on a credit card. Then another bill goes on another card. Credit card bill after credit card bill, each one feeling temporary.

It is not temporary, because the business underneath was never making money. Every card is borrowing to fund a loss. Eventually the bubble pops. The seller owes £20,000 or more, has nothing to pay it with, and goes bankrupt.

What makes this painful is that it was avoidable. The numbers were there all along.

Borrowing is not the villain. Leverage can be very powerful: used to fund stock you know sells at a profit, it can help a good business grow faster. Used to keep a loss-making business going, it is very dangerous, because it lets the losses run longer and makes them bigger.

The tax bill nobody saved for

The other way high turnover catches sellers out is tax. When money arrives all the time, it is easy to treat all of it as yours. Some of it is not.

If you are VAT registered, part of every standard-rated sale belongs to HMRC. At the standard rate of 20 per cent, one sixth of a VAT-inclusive price is VAT. You hold it for HMRC until your VAT return, usually every quarter. A seller who has spent that money on stock has a problem every three months.

Profit is taxed too. A limited company pays Corporation Tax at 19 per cent on profits of £50,000 or less, and at the main rate of 25 per cent on profits over £250,000, with marginal relief in between. The bill is due nine months and one day after the end of the company's accounting period. By then, the cash that earned the profit has often been spent.

This is rarely carelessness. The seller never had a clear view of the profit, so never knew how big the bill would be.

What to do instead

None of this needs complicated software. It needs a few habits.

1. Work out your profit every month, not just your sales. Take what came in and deduct the cost of the stock you sold, your fees, advertising, postage and returns. The difference between contribution margin and true net profit is the number to watch.

2. Move the VAT out of reach. If you are registered, VAT is due on the full price your customers paid, not on the payout that lands after the platform's fees. As each payout arrives, move one sixth of the standard-rated sales it covers into a separate account, and treat that account as HMRC's money.

3. Set money aside for Corporation Tax or Income Tax as the profit builds, rather than in a panic when the bill lands. If you sell as a sole trader, an estimate of what an online seller keeps after fees and tax gives you the figure to set aside.

4. Look hard at any credit card balance that is funding stock. If you cannot say what profit that stock will make, find out before you borrow again.

At the end of this month, ask two questions. Did the business make a profit after every cost? And is the money for the tax bill sitting somewhere you will not spend it? If the answer to either is "I don't know", that is the job for next week.

About the author

Harvey Dhillon is the founder and CEO of Zmartly, a UK accountancy firm for ecommerce sellers. He grew up in West London and worked in finance roles in investment banking, wealth management and private equity, starting at Barclays, before leaving in 2020 to build the firm. He is a Chartered Management Accountant (ACMA, CGMA).

Image: Zmartly.