The exponential growth in online sales is the stuff other industries can only dream about, with e-commerce stores amassing over 2 billion shoppers and bringing in more than $4.2 billion in sales during 2020 alone.
If you’re selling your products on a third-party marketplace or your own website, you’re probably enjoying the online sales rush. But to keep up with demand and continue to scale consistently, there’s one area you need to pay close attention to: your cash conversion cycle.
With a firm grasp on your cash cycle, you always know when is the perfect time to purchase more inventory. Not only that, you’ll also have enough cash on-hand to put out unexpected fires, invest in a new product launch, or even scale to a whole new market.
Sounds pretty great, right? Let’s dive in!
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A cash conversion cycle (CCC) — a.k.a. ‘net operating cycle’ or simply ‘cash cycle’ — is the process of buying materials, turning them into stock, and converting them back into cash through sales, as defined by a set time period such as the number of days or weeks.
As an e-commerce metric, CCC has three stages:
A high CCC indicates a sluggish process, whereas a low CCC shows that your business moves stock efficiently and gets paid quickly. Now, what exactly counts as a high or a low CCC isn’t set in stone — it depends on specific variables like your product niche, territory, and business resources.
Regardless of your category, there are a few core things that can impact your CCC:
Let’s take a closer look at the can’t-miss benefits of a healthy cash cycle, then dive into the simple three-part formula for how to calculate it.
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A healthy cash conversion cycle can be a pivotal growth lever for your business.
But when you’re busy with a growing e-commerce store, your CCC can easily get bumped down the to-do list.
Here are a few reasons why optimizing your cash conversion cycle is 100% worth your time:
Now that you know what a strong CCC can do for your business, let’s get down to the hard numbers.
There are three metrics that go into a cash conversion cycle formula:
Here are the formulas:
*Note: Average Inventory = Beginning Inventory + Ending Inventory / 2
When you pull these three formulas together, you get the Cash Conversion Cycle formula:
DIO + DSO – DPO = CCC
In action, calculating your CCC formula could look like this:
But numbers can only show you so much. To really understand how your cash cycle can impact your success, let’s take a closer look at a real-life e-commerce case study.
If you haven’t heard of sportswear brand Gymshark, it’s time you did.
What started out as a part-time business run from the founder’s garage, quickly grew into a billion-dollar company with little external funding — simply by building a negative cash conversion cycle.
Thanks to its extraordinary cash flow strategy, the company’s growth was essentially paid for by its suppliers (without them even knowing it 😉).
Today, the well-loved brand averages at around 36 days of cash available per item sold, which provides them with the flexibility to invest in new products and grow without the pressure of external investors or interest charges.
The result? Gymshark is now worth over $1.3 billion.
So, how can you follow in Gymshark’s footsteps? Here are a few ways to smash your goals with a negative cash conversion cycle:
Gymshark’s incredible growth story is just one example of why a negative cash conversion cycle is the optimal position to be in. By raking in the cash before you have to pay your obligations, your business ends up with more cash-on-hand for longer and greater overall liquidity.
Still not sure where to start?
Here are a few more ways to start transforming your net operating cycle and make sure your cash flow works for (and not against) you.
Sharpen your invoicing processes
To shorten the time it takes customers to go from invoiced to fully paid, you need to optimize your invoicing processes. Make invoices easy to produce and understand, and ask your customers for feedback to make your payments process easier.
To avoid fluctuations in payment frequency and amounts, standardize your payment terms and avoid extending return policies beyond industry and legal minimums. Set up your payment terms when shoppers buy the goods or right before delivery to avoid chasing payments after the goods are delivered.
Work with your suppliers to extend payment deadlines and combine orders to reduce time-wasting admin. Be sure to sell the benefits of this setup to your suppliers — consider the fact that they’ll get larger, more consistent payments. For this approach to work, you need to demonstrate your company is trustworthy. Build a record of timely and complete payments to decrease your risk profile in the supplier’s eyes.
An optimized cash conversion cycle can set your store up for major success.
By maintaining enough cash to fund new projects while keeping your existing operations afloat, you can save money and become less reliant on external funding.
It takes time and effort to get your cash conversion cycle running smoothly — but the results are worth it. With enough cash to cover new ground faster than your competitors, you’ll become a leader in your niche in no time.
Is a long cash conversion cycle holding you back? Find out how SellersFi can help you break free.
