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Drop shipping is poised to take the retail world by storm. A report in the Wall Street Journal found that 40% of businesses surveyed planned to work with more drop shipping vendors in the coming year. Brands like Home Goods and Pier 1 Imports, among others, are already embracing drop shipping.
To get in on this retail revolution, readers should first brush up on a few common financial terms and principles related to the drop shipping business. This article will provide readers with thirteen of the most important financial terms every drop ship business owner should know.
Collection on Delivery
Also known as COD, this term refers to a shipping practice where the customer pays the shipper when the package is delivered. This means that rather than pay for a product online, the customer can simply give the delivery person a credit card, and once paid, the recipient will be given the package.
This can be a good method for retailers who are just starting out. It means that a business owner won’t even need an e-commerce store in order to start selling products. In time, it will make sense to move away from a COD model, for the sake of convenience. But in the short term, COD makes it easier to create a minimum viable product to test the market.
Employer Identification Number
If you are starting a new business, be sure to properly incorporate it and apply for an employer identification number (EIN) via the Internal Revenue Service. This number is used by the business owner when paying taxes, and it is used by company employees when reporting their income.
Depending on where and how goods are being imported from overseas, an import duty may be levied by US Customs upon entering the United States. The US government uses something called the Harmonized Tariff System to determine what is owed upon importing an item to the US. Before committing to importing a particular product, be sure to calculate the tariff that will be owed (if any) in order to properly calculate the real cost of the item in question.
This term simply refers to the expenses a business has that must be deducted from gross revenue in order to calculate net revenue. Usually there are fixed and variable costs to running a business. Fixed costs are things like rent, or internet hosting fees. Variable costs are usually things that change over time, like the price of gas or the price of employee insurance.
Usually, drop shipping companies are able to operate with less overhead costs than other business types because goods do not need to be stocked as they are being shipped directly from the manufacturer.
Customer Acquisition Cost
This term is often abbreviated as CAC, it can be calculated by adding all of the overhead costs associated with attracting and winning new customers, then divide the number by the number of customers won. Customer acquisition costs typically include things like advertising costs or the cost of marketing team salaries.
Cost to Serve
Once a prospect becomes a customer, there is often a cost to serve this customer and in making your site look nice. This cost is known as CTS or cost to serve. To calculate this cost, add all of the costs associated with serving your customers, and divide this number by the number of customers your business has. Typical CTS expenses include the customer support salaries and shipping costs.
Customer Lifetime Value
One study estimates that the lifetime value of an Amazon prime customer is over $2,000. Lifetime value (or LTV) refers to the amount of money a customer will spend with your business for the entirety of the time a customer works with your business. For example, an Amazon customer might spend $5 on Amazon buying toothpaste today and might spend $500 on Amazon buying a new TV in three months. LTV allows business owners to understand how valuable each customer is, which in turn makes it easier to know how much to spend acquiring and serving each customer.
Cash flow is an accounting principle that compares the amount of liquid assets a business has on hand, to business expenses. A company can be highly successful, and still have poor cash flow due to high upfront operating costs. Conversely, a business can be doing relatively poorly and still have positive cash flow, making it possible to sustain operations within limited overall capital.
Think of liquidity as a spectrum from illiquid to liquid. On the illiquid side is an asset that is hard to convert to cash. Owning a valuable piece of manufacturing equipment with a small number of potential buyers is an example of an illiquid asset. Whereas having cash on hand is an example of the most liquid asset of all. Liquidity will help you forecast cash flow scenarios by understanding how easy or difficult it will be to free up assets to support business operations if need be.
Pay per Click and Cost per Impression
These terms refer to common digital advertising models that business owners should be aware of and should understand the unique strengths and weaknesses of. Pay per click (PPC) means that a digital advertiser will pay an advertising platform like Google Adwords or Facebook each time someone clicks on the ad.
Cost per impression (CPM) means that the advertiser will pay a set fee each time an audience member looks at or engages with an ad. Usually, CPM is calculated in hundreds or thousands of impressions.
Cost per Lead
Many digital advertisers will use cost per lead as a way of determining whether or not an advertising strategy is cost effective. To calculate the cost per lead (CPL) divide the number of leads generated by the amount spent to acquire the leads. Then compare CPL across platforms to understand what methods are most cost effective.
Gross and Net Revenue
Businesses of all sizes experiment with financial reporting in gross and net revenue terms. Gross revenue refers to the amount of money a business made through sales before subtracting costs. Net revenue (or income) refers to the amount of money remaining after subtracting expenses.
One study found that about 30% of all products ordered online are returned. When a customer returns a product, it is customary to charge the customer a restocking fee to cover the expenses involved in handling the returned item. This fee can help business owners to defray costs that would otherwise be absorbed.
Drop shipping is quickly becoming a trendy way to create a successful and scalable business and generate revenue. To ensure that your business is poised for success, be sure to carefully monitor the thirteen financial metrics and terms outlined in this article.