What would you do if you could untie that capital and suddenly free cash flow to invest in your business? Music to your ears, right?
But if you’re like most DTC brands, most of your working capital is tied up in inventory—inventory that sits in warehouses, accruing costs.
By better understanding consumer demand for their products, brands can achieve inventory optimization and run a lean operation.
Plus, by doing this, brands could avoid having so much working capital tied up in unsold inventory in warehouses. And consequently, they could free up their cash flow to reinvest in their best growth channels.
But first, brands need to know what they need, so they know why they’re freeing up working capital in the first place.
Have you ever looked at your business in terms of Maslow’s hierarchy of needs?
As Maslow pioneered, each lower stage of our human needs must be fulfilled before we can move on to the next one. In the same way, your business’s needs must be fulfilled before being motivated to reach the next level at whichever stage your business currently is.
When a brand understands what stage they are in and why they need to grow, they can define what this growth looks like (or the next step in the journey). From there, they can easily decide how to invest their capital to get there.
Generally speaking, there are two options for making this growth happen: top-line growth or bottom figures growth. Top-line growth refers to increasing the brand’s gross revenue or sales. Meanwhile, bottom figures growth refers to increasing the company’s net income.
More often than not, brands opt for top-line growth. And there are a few options for making this happen:
In a small LinkedIn poll, we asked 67 brands which methods they’re currently using to grow their top-line revenue. Nearly half said they were or wanted to grow by investing capital in developing new products.
Clarity on why you’re freeing up working capital makes reaching the goals much easier.
That’s because knowing why you want to grow makes figuring out how to do it operationally and actually achieving that goal much easier.
So, let’s break down the four most common reasons why brands free up working capital: to grow, to secure safety margins, to pursue new innovations, and to distribute profits to shareholders.
Whichever of those four why’s you identify with gives you insights into your business needs. We’ll break down what that is and what you can do with free cash flow to get it.
Let’s start with growth.
Every business ever wanted to grow in some way or another.
But there are different ways to grow. I personally am a big proponent of growing better, not just bigger (that’s how I built the Woo brands and how I intend to build Cogsy).
So, let’s walk through a few ways you could grow a retail brand with newly freed-up working capital.
The most accessible option for brands that want to pursue top-line growth is to double down on customer acquisition channels that already work for them. If a brand pours more money into what is already working, it can increase the rate at which they grow.
The most obvious channel here might be paid acquisition.
Say a brand is spending $1,000 on Facebook ads, and they get 100 customers for that. How many more customers might they get if they increased their spending to $2,000? It will most likely scale and nearly double the number of customers acquired in that channel.
The funnel metrics may not always extrapolate in the same ratio, though. When increasing spending in a channel, the cost of acquiring each customer (CAC) often increases with it because the audience is being maxed out, depending on the audience size.
Extending budgets on what is already working is a quick way to enable growth, but it’s typically not a long-term solution.
Another option for brands with freed-up working capital is launching new products or experimenting in new channels.
Cash flow and budget size are usually a constraint when testing out these options. Experimentation in new channels can be hard to justify when the margin is tight. Having more cash on hand can allow teams to expand their reach or break into new markets.
One example of where a brand might invest in a public relations (PR) firm or test a new outreach method. And having free cash flow might enable teams to hire an agency or freelancer to help execute these new kinds of outreach.
Retail brands constantly need to add bandwidth to their team. With more cash reserves available, a brand can hire new team members to create new products, produce more content, or answer growing support tickets when needed.
In other words, when teams are stretched thin, brands can add bandwidth by asking: who do I need to hire and to which team?
Doing so allows the brand to grow on the marketing and customer experience side.
But depending on the brand’s product line, it may also be wise to hire someone full-time to build one-on-one relationships with your best customers and do the things that don’t scale.
Doing things that don’t scale takes time. For more time, businesses need more humans.
By freeing up working capital, brands can consider investing in people to pursue these unique and important growth initiatives.
Another place brands can invest working capital to unlock growth is product research and development (R&D).
Brands are always thinking about expanding to new products. On The Checkout podcast, we spoke to José Alvarez, co-founder of Abbott, an up-and-coming fragrance company. He shared plans to move from fragrances and candles into body lotions coming soon.
“Who knows, what if someone wants to have an Abbott deodorant in the future?”
But while consumers may want new products from your brand, spinning up new products isn’t as easy as it sounds. It’s expensive, and it takes careful research and planning to get it right.
On this note, José shared: “We did a lot of research. We found out how the industry works and the trademark secrets. For example, 4 to 5 perfume houses make 95% of the perfumes that you wear. There are a lot of licensing deals, and so on. We raised money with our business plan and research, so we did a lot of legwork.”
With capital to invest in product R&D, brands could expand existing product lines to reach:
Product R&D is notoriously expensive, so none of this is possible without the free cash flow to invest. By freeing up more working capital, new products, and tapping into new markets becomes a clear possibility.
The question becomes: can we buy access to this growth? The answer is a resounding yes via increasing advertising spending, hiring more team members, launching new products, or a plethora of new initiatives. Brands can use their free cash flow to expand their footprint.
While growth is a worthwhile goal in and of itself, it’s not the only target brands can hit by freeing up working capital.
Another crucial benefit of reducing costs tied up in inventory and freeing up cash flow is to create a bigger safety net and allow a brand to be more agile in terms of capitalizing on sudden opportunities.
As with life, business is unpredictable. Opportunities and challenges pop up when we least expect them. Just like a COVID-19 pandemic, brands will forever face uncertainty and need to adjust quickly to survive. Having free cash flow helps them do that.
Cash flow is the most critical piece to a business’s survival.
Over one-third of the small businesses that closed in 2021 attributed their failure to a “lack of capital.”
Meaning, the main reason was they ran out of cash. That does not mean that its business model or product quality is not at fault—most often, it’s simply a matter of cash flow.
To combat that dreaded fate, businesses could create a bigger safety margin of cash reserves.
Having a greater safety margin would help businesses weather the storm or unexpected situations.
The ability to face uncertainty with greater cash reserves in the bank is a great thing to have in business.
It provides founders and team members with less anxiety and a more relaxed approach to solving problems in unforeseen circumstances.
If a brand has greater cash reserves, it acts as dry powder—funds available to deploy when an attractive opportunity arises.
And in such a volatile market, you want to be able to capitalize on opportunities quickly. But if you don’t have cash on hand, you may miss your shot completely.
Say that you’ve instated lean operations, and you only order the inventory you need (and no more). Naturally, you’ll also free up working capital, meaning you’ll be in a position to capitalize on a good opportunity that comes your way, like:
If you’re tight on budget and cash, you can’t do those things as quickly. Greater cash reserves allow you the agility to make opportunistic decisions in real-time.
Having margin in a business gives founders and operators more flexibility around how they run the business.
I wrote an entire book on this titled Life Profitability. I’m a firm believer in having increased options for you, your employees, and your community. Part of that is giving yourself (and your team) space to make decisions that may run counter to accepted business best practices.
Amidst the pandemic, more companies are taking a people-first approach to how they work together. Remote work is no longer the outlier—it’s common practice. Instead, four-hour workweeks and completely asynchronous communication are taking over as the new way to work.
For example, the software company Doist recently rebranded its team collaboration tool to Twist. The rebrand aims to serve the companies adopting this shift.
At one point, their website read: “Async is the freedom to collaborate on our own timelines, not everyone else’s. It’s the power to protect our best hours for focus and flow.”
Flexibility and optionality around how you work and organize your team may not be a top priority for some, but a small subset of founders want to experience a sustainable sense of peace in their day-to-day work.
It’s liberating to have options to run your business and grow your brand in whatever way makes sense for your life. Freeing up working capital allows you to do that.
Investing in innovation can sometimes feel like playing roulette. It’s a risky bet that can 10x the business or completely flop. But you never know before you try.
But to pursue innovative initiatives, brands need free cash flow to invest in new projects—enough of it to give team members the space and freedom to experiment.
If you have the budget, it can be very beneficial to allocate 5-20% of your budget toward experimental bets that aren’t guaranteed to move the needle forward. That’s because these initiatives are the ones that can 10x the business if they work.
One of the most well-known examples of this is Google. They allowed anyone to work on anything for 20% of their time on the company’s dollar.
Their internal documents state: “Most 20% projects do not make it to the next level. But the few that achieve critical mass eventually lose their 20% status and become official Google projects… We estimate that about half of Google’s products, including Gmail and News, started out as 20% projects.”
In other companies, side projects tend to work, as well. (Did you know Slack was born as a side project?)
Most brands focus on linear projects that only incrementally grow the business. So, innovative projects, on the other hand, are the ones that can possibly level up the business way faster. If a brand has that innovation budget, what are those venture-like things they could do internally to keep moving the needle forward?
Having extra cash on hand allows brands to extract profit through dividends and distributions to return money to the shareholders.
If a business is really profitable and has good cash flow, what would it look like to return value to the shareholders? This, of course, depends on what the appetite is for returns and the business’ mandate.
Another option is rewarding the team. Profit-sharing is a short-term reward versus building the business for the longer term. Still, it does serve to motivate your team to work toward future success.
Bob’s Red Mill, a whole-grain foods brand, is famous for profit-sharing. With plans to transfer ownership of the company to its employees, Bob describes the profit-sharing program he created just three years after founding the brand:
“Employees see a direct benefit from their efforts, and it teaches them to think like a boss. The harder they work, the more they get.”
These strategic decisions are only available to owners, shareholders, and operators if the cash flow is available.
Freeing up working capital isn’t easy. It takes intentional effort to get your leadership team on board and optimize your inventory to run a leaner operation. (Cogsy can help with that.)
To motivate your team, remember all the new projects and growth initiatives you could pursue with the free cash flow that will become available to you.
Get inspired to free up your brand’s working capital. Now that you’ve examined all the projects you could take on once you have more free cash flow, what’s stopping you?