THE PROBLEM WITH GROSS MARGIN ALONE
You check your P&L. Gross margin looks healthy, 70%+. You feel good. Then you look at your bank account and wonder where the cash went…
Your gross margin is not the cash you get, minus your operating expenses once you’ve sold you’re inventory, you’re forgetting to factor in your average cost to acquire a new customer and your blended CAC for both new & existing customers.
In a retail world where paid acquisition is a cost of goods in everything but name, gross margin is structurally incomplete. It assumes customers appear for free. They don't.
You also don’t get the cash back from your inventory purchase until you’ve sold it all, this highlights another important frame to look at, your cash conversion cycle, more on that here.
Your gross profit minus your avg CAC is your actual net profit before operating costs.
It’s odd to me how many ecommerce business owners don’t track or understand net contribution margin. It’s a much more accurate representation of the net gross profit of a product when you’re spending on paid ads.
What Net Contribution Margin is & The Formula
Most people will calculate their gross profit unit economics but never factor in the cost of acquiring a customer too. Your gross profit minus your avg CAC is your actual net profit before factoring in operating costs.
It’s a true representation of what cash flow you can expect to make after ad costs and it is super helpful in managing cash flow.
The calculation is super simple, just calculate your normal gross profit margins and margin dollars and then minus your avg CAC and this is your net contribution margin.
For example:
Product RRP: $100
Landed COGS (product, freight, packaging): $20
Fulfilment fee: $3
Merchant fee’s: $2
Other transaction fee’s (paypal, afterpay): $2.10
Gross profit: $72.90
Avg CAC: $50
Net contribution margin: $22 (22%)
Your contribution margin target is unique to your business, but a good benchmark is 20%-40%, depending on your strategy. If you’re breaking even on each first order it would be 0% and for some it may be below 0% for new customers.
Your blended NCM should defiantly be above 25%-30%, think about it like this…
If you’re making 20% NCM on each order, when you factor in opex costs which for a lot of business range between 10%-20%, lets use 15% as an avg for this example, that would mean your net profit after everything would be the 20% NCM minus the 15% opex, leaving you with net 5% profit for the business as a whole.
That’s why tracking your NCM & is important!
It’s also just as important for cash flow, ecommerce is a cash demanding business and is complex…
Your cash flow strategy can be the difference be thriving & dying.
For consumables brands, your first-order NCM and your blended NCM are two different numbers, and both matter.
For example, If you have 60 day payment terms with your supplier (you can pay your manufacture 60 days from when they start manufacturing) you may get your stock in 30 days and have another 30 days before you have to pay for your inventory.
| First Order | Repeat Order | Blended (assuming 3 orders/yr) | |
|---|---|---|---|
| Revenue | $100 | $100 | $100 |
| COGS + Fulfilment | $27.10 | $27.10 | $27.10 |
| CAC | $50 | $0* | ~$17 |
| NCM | $22.90 | $72.90 | $55.90 |
But you know on average it takes 90 days to sell your stock, that means you have to pay for your full stock 30 days before you get the cash from that stock. If you’re NCM is below $0 you may run out of cash before for ads before you can sell out of all the stock.
For example:
Inventory: $100,000
Gross margin: 72%
Inventory value: $100k/0.28 = $357,142
Gross profit: $257,142 (72%)
Avg CAC: 50% , $178,517
NCM: $78,571 (22%)
| Day | Event | Cash In | Cash Out | Running Position |
|---|---|---|---|---|
| 0 | Order placed (60-day terms) | — | — | $0 |
| 0–60 | Selling 67% of stock | +$238,095 | -$119,047 (CAC) | +$119,048 |
| 60 | Supplier payment due | — | -$100,000 | +$19,048 |
| 60–90 | Selling remaining 33% | +$119,048 | -$59,524 (CAC) | +$78,571 |
| 90 | Cycle complete | — | — | $78,571 |
In this example you’re in a positive cash flow cycle. But what if you didn’t have 60 day payment terms of it took longer to sell through your inventory?
Lets take an example of 30 day payment terms
| Day | Event | Cash In | Cash Out | Running Position |
|---|---|---|---|---|
| 0 | Order placed (30-day terms) | — | — | $0 |
| 0–30 | Selling % of stock | +$117,856 | -$58,928(CAC) | +$58,928 |
| 30 | Supplier payment due | — | -$100,000 | -$41,072 |
| 30–90 | Selling remaining 67% | +$239,285 | -$119,642(CAC) | -41k+239k-119k |
| 90 | Cycle complete | — | — | $78,571 |
In this scenario you are $41k in negative cash given the terms and your stock + CAC position, so you better have at least $50k in the bank from to fund the days 30-90 ad spend.
NCM isn't just a profitability metric. It tells you whether you can survive the gap between when you pay for things and when customers pay you. Low NCM + short payment terms + slow sell-through = existential cash problem.
If your blended NCM is above 30% but you're constantly cash-stressed, your sell-through velocity is the problem, not your margins. The cash conversion cycle post explains why.
Three things you can do next:
- Calculate your actual NCM per SKU (not blended across the store)
- Map your cash conversion cycle against your payment terms
- If you're a consumables brand, calculate your blended NCM at 2x and 3x repeat purchase, that's the number that tells you whether your acquisition spend is actually working