How Kate got stuck in the eCommerce debt trap
“Kate”, one of our eCommerce clients, was caught in an eCommerce debt trap. Her private label brand had been growing 200% annually for three years, but cash flow was tight, and she struggled to pay suppliers. During a client meeting, she revealed her frustration, feeling like she was working just to repay inventory loans.
With Q4 approaching, she placed a $580,000 inventory order and paid a 30% deposit. However, with $406,000 due the next month when manufacturing was completed, she didn’t have enough cash to cover the balance.
Like many entrepreneurs, Kate took a short-term eCommerce loan. These were the terms of the loan:
- Total capital $400,000
- Repayment total of $442,000
- Repayment terms are 10% of revenue daily with a maximum repayment period of 6 months
- The cost of the loan was a massive $42 000!! Annualized this is an effective APR % of 21% minimum!
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:
- Accurate COGS (Cost of Goods Sold), including all landed costs.
- 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:
ORIGINAL SHORT TERM LOAN
- Applied to one lender
- Total capital $400,000
- Loan type: eCommerce loan
- Maximum repayment period of 6 months
- Repayment terms:10% of daily revenue
- Effective annual interest of 21%
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.