Kate used the loan to pay her supplier. The very next day, she began repayments, paying $1,100 on $11,000 in Shopify sales.
Three months later, when the new inventory arrived, Kate had repaid $380,000 but had no cash left for herself or to fund her next inventory deposit.

To keep up, she took out another loan—this time for $680,000—trapping her further in the cycle. What was Kate to do?

Let’s understand Kate’s eCommerce debt trap

Kate’s business has a solid net 15% profit margin and fast-growing sales, but she’s stuck in a debt cycle due to short-term loans with high interest rates. Let’s consider the profit cycle quickly:

• Inventory order to goods received: 5-6 months
• She sells through that inventory in 3 to 5 months
• Total cycle (order to profit): 8-11 months
• Her loan repayment period is 6 months

Her profit cycle takes 8-11 months, but her loan repayment is capped at 6 months, forcing her to repay debt with profits from the previous cycle.

Key takeaway – The loan period is too short!

It takes her up to 11 months to turn the inventory payment into a profit, but she has to pay the loan back in 6 months. The term of the loan is not long enough to match her needs. That is why she never has anything left over for herself!

Key takeaway – The interest rate she is paying is higher than her profit margin!

Her effective interest rate on an annual basis is 22.1% at best if she takes six months to repay, but she usually repays within 4 months so effectively her annualised rate (APR) is 33.15%. This rate is higher than her profit margin. Kate is effectively working for the lender and paying them all the profit she makes and she pays them before she pays any of her fixed costs.

Madness, right? Then why do just about all the eCommerce founders we meet live like this?

How did Kate break free from this eCommerce debt trap?

We’ve worked with over 200 eCommerce founders, and this problem is all too common. Fortunately, there’s a solution. In Kate’s case, we helped her break the cycle with a three-step process that set her up for long-term success while maintaining healthy cash flow:

1) Get the right financial data

Kate’s plan to break free from the debt cycle would have been impossible without two key accounting figures:

1. Accurate COGS (Cost of Goods Sold), including all landed costs.
2. Proper amortization of the effective interest expenses on her short-term eCommerce loans.

Without this accurate data, we couldn’t properly analyze her financial situation, and provide a reliable foundation for forecasting. If these numbers had been off, Kate’s rapid growth and increased borrowing would have silently driven her toward bankruptcy instead of success.

2) Securing the right funding

We brought in one of our CFO partners, who has strong connections with banks and small business loan providers. Together with Kate, the CFO, and our team, we developed cash flow projections and a solid business plan, then applied to multiple lenders for a 2-year small business loan.

The best offer came with a 2-year term and a 6-month interest-only payment holiday, at an annual interest rate of 13%—a significant savings compared to the 33.15% she had been paying.

The loan was large enough to cover the remaining $200,000 from her previous eCommerce loans and fund her next $600,000 inventory order. The 6-month interest-only period gave Kate the breathing room to implement the second phase of our plan, setting her up for sustained growth.

See how the two loans stacked up against each other:

NEW LONGER TERM LOAN

• Applied to multiple lenders
• Total capital $800,000
• Loan type: Small business loan
• Maximum repayment period of 2-years
• Repayment terms: Monthly 
• Included a 6-month interest-only payment holiday
• Annual interest rate of 13%

3) Put aside funds for inventory based on COGS

Next, we had Kate open a second bank account dedicated to future inventory purchases. She would regularly transfer money into this account based on her COGS (Cost of Goods Sold) from her accounting reports (which must be accurate for this to work!). Given Kate’s rapid sales growth, we recommended she transfer COGS plus an additional 10% each week to ensure she was prepared for upcoming inventory needs.

This weekly practice, inspired by the “profit first” methodology, helped her build the discipline of setting aside funds from each day’s or week’s sales to cover future inventory costs. While there are some criticisms of this approach, the benefits of budgeting for inventory far outweigh any downsides. And yes, it’s smart to park this money in a fixed deposit or money market account to earn interest!

A happy ending…

A year later, Kate had built up enough funds in her inventory savings account to cover both her upcoming inventory deposit and final payments. She was also able to allocate the remaining $80,000 from her loan to boost her marketing efforts. No longer burdened by high-interest short-term loans, Kate was finally able to pay herself a salary.

This success even led her to open another savings account—this time to plan for taxes on her profits, a welcome challenge that marked a healthy shift in her business.

Traditional ROAS Formula:

The traditional formula for ROAS is Gross Revenue / Ad Spend, but this oversimplified formula hides key expenses, like product costs, fees, and shipping, which all eat away at your bottom line. Ad agencies can sometimes use this oversimplified formula to measure success and performance bonuses. Beware! You need to ensure that you are using a measure based on profitability not on revenue.

We sat down with James to walk through his actual numbers. Using what we call True ROAS, which factors in all the relevant direct variable costs, we uncovered the full picture. Here’s how it works:

Example: True ROAS Calculation:

• Gross Revenue: $10,000
• Minus Discounts: $1,000 giving net revenue of $9,000
• Minus Landed Product Cost: $4,500
• Minus Selling Fees: $1,500 (Amazon selling commissions and Shopify transaction fees)
• Minus Outbound Shipping: $2,500 (FBA and 3PL costs including courier to clients)
• Profit Contribution Before Ad Spend: $500
• Divided by Ad Spend: $2,500
• 20% ROAS ($2000 loss)
• Loss after Ad Spend was ($500 – $2,500) = $-2,000

GOING FROM A POSITIVE RETURN TO A NEGATIVE RETURN?

James went from thinking he had made a 4 times (or 400%) return on the investment in advertising spend, to realizing that in reality, his return was only 0.2 times (20%) his investment on advertising spend. After reviewing this, James was not so happy to pay the agency a further $300 for an incentive on a loss-making campaign.

James has now learnt how important it is to supply his agency with accurate costing and profit information so that they can measure their performance in an accurate manner that results in truly profitable growth for his business.

Why Does True ROAS Matter?

If you only focus on traditional ROAS, you might think you’re doing great when, in fact, you’re losing money. True ROAS accounts for all of the direct costs that can quietly erode your profitability, including:

• Landed Costs: The total cost to get products into inventory.
• Marketplace and Merchant Fees: Shopify, Amazon, PayPal, and Stripe fees.
• Outbound Shipping: Costs from FBA, 3PL providers, and couriers.

Get Better Insights, Make Better Decisions, Earn More Profit

By shifting to True ROAS, you can set more meaningful KPIs (Key Performance Indicators) based on profit, not just revenue. This ensures your business stays profitable while advertising to grow, no matter how high your ROAS climbs.

Important note, make sure you are using an accurate landed cost for the product costs that is up to date based on recent purchase orders delivered. If you are just using the supplier’s buy cost without any landed cost adjustments for freight and customs, you may end up with inaccurate profitability measures.

Don’t let a misleading ROAS put your business at risk. Take a closer look at your financials today.

One way to keep track of this is by reviewing your income statement and measuring profit contribution before advertising as a percentage of net revenue. This gives you a clear view of your performance on a monthly basis and helps you set a meaningful Key Performance Indicator (KPI) to target.

Using this method you will get a better understanding of the true costs and can make changes so that you actually make money.