Last Updated on June 12, 2026 by Jason Andrew
At some point in our lives, we’ve all thought about a Shopify store.
What if you printed the face of your dog and put it onto water bottles?
Maybe you could design a better logo for the website…
Or perhaps you’ve thought of a new product feature that you wish existed.
“Chat – one shot an ecommerce business that makes me $2m a year so I can sit on the beach. Make no mistakes”
So you set up a website, order 200 units from Alibaba to prove the concept, and run some facebook ads.
12 months later, and things are going … Okay?
You’ve got some paying customers in the door. Revenue is growing.
But you’ve sunk all your cash into inventory, and the repeat customers just aren’t showing up.
Is this is a business, or a money pit?
Let’s break it down.
Understanding Unit Economics
Unit economics are the hallmark of any business but especially important in ecommerce.
The goal for unit economics is to have numbers which improve over time, such that your business will get progressively more profitable as it grows.
If your unit economics are worsening as you grow, your business will deteriorate as you scale.
But let’s define some key terms first.
The following metrics will be your best friend when diagnosing whether or not the business is working.
Average Order Value (AOV)
In other words, how much the average customer spends with you when making a purchase.
Typically speaking, having an AOV north of AU~$100 is a good sign that you will have enough room to make the economics work for your business.
For context – Speedcommerce data benchmarked the ‘average’ Shopify store AOV at AU~$140, with the top 20% of stores recording AOV’s of AU$300+.
Lower than this and it will be extremely hard to get the economics to work.
But there’s a caveat here.
Depending on your customer’s purchasing pattern, a higher or lower AOV might be more appropriate.
If your good is a consumable, like dog food, or supplements, then it’s possible that you could get away with a lower AOV given that they will be coming back again and again.
These types of businesses can afford to have poorer unit economics on any individual order, because they will make up for high CAC’s over the life of the customer.
But more on CAC later.
Gross Margin
Gross Margin is your best friend with any physical product – the higher the gross margin – the more likely your business will be profitable.
Basically – how much does an individual unit of your product generate you in ‘profit’ before accounting for any of the indirect costs of the business.
As a general rule of thumb, having ~70% gross margins generally provides enough cushion to account for customer acquisition expense, and other operating costs, to ensure that the business can continue to grow profitably.
| Company | Gross Margin | EBITDA | Net Profit Margin |
|---|---|---|---|
| StepOne | 80.8% | 21.4% | 14.6% |
| Hims / Hers | 79.4% | 9.7%* | 8.4% |
| Warby Parker | 55.3% | 2.0% | -2.6% |
| Carter's | 48.0% | 8.90% | 6.50% |
| AllBirds | 42.7% | -37.0% | -49.0% |
| The Honest Company | 38% | -0.1% | -1.50% |
Looking at some publicly traded DTC businesses, there is a very strong correlation between gross margin and net profit margin.
It’s really hard to maintain profitability with <50% gross margins.
You have to pay for customer acquisition costs.
You have to pay for salaries, software subscriptions and other administrative costs.
And then you need enough of the pie left to eat yourself.
If your gross margins are too low, it’s just not going to work.
Contribution Margin vs Gross Margin
For ecommerce businesses, there’s another metric we also tend to look at called Contribution Margin.
Lots of people use the terms interchangeably, but there are actually slightly different.
Notably, your contribution margin includes all variable costs.
In an eCommerce business, gross profit usually includes the direct product cost, inbound freight into your warehouse and last mile delivery. Contribution margin then goes further by capturing the variable costs required to acquire and fulfil the sale such as advertising, marketing, 3PL and fulfilment.
Breaking down your P&L like this is very helpful to understand where your business is spending money, and how the numbers are changing from month to month.
Customer Acquisition Cost (CAC) and Lifetime Value (LTV)
AKA how much do you have to pay to bring a new customer in the door?
For an ecommerce business, these costs are typically associated with the cost to acquire a customer through Facebook Ads / other paid digital marketing campaigns.
What’s useful though is to compare the CAC to LTV. In other words, what is the cost to acquire a customer versus the lifetime value of that customer.
If it costs you $2 to bring a new customer in the door, then that customer needs to generate at least $2 in gross profit for you to recoup that investment.
In reality though, we need CAC to LTV to be much better than that, particularly during initial testing.
This is because the golden rule of marketing is that over time – CAC will go up.
This is because the customers that are most aligned to your product, and bought in on the vision will usually purchase the product first. Then over time, as you saturate a market, you will need to continue to attract customers who are less and less relevant.
A LTV:CAC ratio of >3 is generally considered good, although anything above 2:1 should be enough to build a sustainable business.
Generally speaking too – CAC will be a function of the industry that your business is in. In more lucrative categories like watches, real estate, or personal finance, CAC’s can be much higher given that the rewards for winning customers in these categories is much higher.
| Item | $ | % of Revenue |
|---|---|---|
| Net Revenue (AOV) | $175 | 100% |
| Product Cost | $31 | 18% |
| Import Freight, Duties & Taxes | $16 | 9% |
| Product COGS | $47 | 27% |
| Gross Margin (eComm) | $128 | 73% |
| Advertising, Marketing, 3PL Charges | $11 | 6% |
| Shipping + Merchant Fees | $34 | 19% |
| Fulfilment COGS | $45 | 26% |
| Contribution Margin | $83 | 47% |
The Cash Conversion Cycle
If you get lucky in ecommerce – you might start to sell loads of products…
Everything is working.
Your business is having a ‘Labubu moment’.
But cash is still draining from your bank account.
Inventory runs out and suddenly all the money that’s leftover is going straight back into paying for new product.
What’s going on here?
Well, you might have a problem with your cash conversion cycle.
How many days does it take you to collect cash from the inventory that you sell.
Before we get started here – let’s define three key terms
- Inventory Days (ID) – how long it takes you on average to sell inventory
- Accounts Receivable Days (AR Days) – how long does it take to receive cash after selling your product
- Accounts Payable Days (AP Days) – how long does it take after purchasing inventory for you to pay vendors
Your cash conversion cycle (CCC) is equal to your Inventory Days (ID) plus to days to collect receivables (AR), less the days to pay payables (AP).
Together, these three factors will determine your cash conversion cycle.
In eCommerce, customers pay at checkout, so cash comes in on day one. The problem is that brands often buy and hold inventory long before it is sold. Those inventory days push the cash conversion cycle into positive territory because cash stays locked in stock on the shelf for a long time before that investment is recovered.
This acts as a constraint on growth for the business, because even if you’re ‘profitable’ on paper – there is always cash tied up in the hands of customers, preventing you from using this money to spend more on ads, or buy more inventory to grow the business.
When the CCC goes negative
In some rare cases, a business may have a negative cash conversion cycle.
For instance, supermarkets often have a negative cash conversion cycle – because they get paid by customers (everyday people) for groceries 60-90 days after they purchase products, but often pay their suppliers on 90-120 day terms.
This creates a ~30 day ‘gap’ where they have received cash from customers before they need to pay their suppliers.
Wonderful.
These businesses ‘unlock sales’ for their suppliers – giving their monopoly bargaining powers in contract negotiations – allowing them to bargain for these favourable payment terms.
Enterprise software businesses also may have negative cash conversion cycles if they get paid for annual contracts upfront at the start of the year.
For your fledgling ecommerce brand though – you won’t have this kind of bargaining power.
Typically – your manufacturer will be much larger than you, serving multiple brands, which will force you to take worse payment terms.
How to Improve Your Cash Conversion Cycle
But what can we do with this information?
Well, you need to think about optimising our 3 levers.
- You need to optimise your product portfolio to focus on selling products which sell fast – reducing the days it takes to sell inventory
- Avoid using payment processes which delay the time until you receive cash. Some processors will offer you more favourable terms (i.e. save 1%-2%) in exchange for receiving cash 30 days later. You want to avoid them if we are focusing on improving your CCC.
- Try to negotiate better terms with vendors. Sometimes, you might need to accept worse margins to improve your payment terms – trading off profitability for liquidity.
That's a Wrap!
If you are building a small Shopify site – hopefully you can apply some of this thinking to work out whether you have a real business, or a cash hungry moneypit.
The answer is almost always in the numbers. Healthy AOV, strong gross margins, a LTV to CAC ratio above 3:1 and a manageable cash conversion cycle are the conditions under which an eCommerce business can compound rather than drain.
If those numbers are not yet working, that is not a verdict. It is a diagnostic. Each metric points to a lever worth pulling.
And if the numbers do look good? You are off to the races.
Frequently Asked Questions
👉 Ready to know your numbers? SBO Financial helps eCommerce founders build financial visibility from the ground up, so you can scale with confidence, not guesswork. We will review your unit economics, cash flow position and map out the clearest path to sustainable growth.
