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!
The Scoop on Cash Conversion Cycles
- What Exactly Is a Cash Conversion Cycle?
- The Game-changing Benefits of a Strong Cash Cycle
- Calculate Your Cash Conversion Cycle with 3 Essential Metrics
- How One Online Retailer Used a Negative Cash Conversion Cycle to Reach $1.3 Billion
Ready to grow your store to the next level? Find out how SellersFi can help.
What Exactly Is a Cash Conversion Cycle?
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:
- Purchasing inventory
- Selling inventory and generating sales revenue
- Paying suppliers for stock purchases
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:
- How you cover inventory costs (e.g, in cash, accounts receivable, external funding, etc.)
- How quickly customers pay
- The speed at which you collect cash for goods
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.
Need a hand mastering your cash flow? Discover how SellersFi can help.
The Game-changing Benefits of a Strong Cash Cycle
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:
- Reduce business costs: When your business turns over stock and gets paid quickly, you can access more capital at a lower cost — and since you won’t be reliant on external funding, it can reduce interest fees and make it easier to run your business your way.
- Provide investors with company performance insights: A lower CCC alerts investors that your business runs at optimal efficiency and has great operational practices. From this information, investors can feel confident they’ll get a return on their investment sooner, making your business more desirable.
- Reduce opportunity cost: The longer cash is tied up in stale inventory, the more opportunities you miss. But with a lower CCC (and the increased liquidity that comes with it) you can capitalize on more initiatives to grow your business.
- Gain a competitive advantage: The quick access to capital you get from a low or negative CCC can help to expand your business horizons sooner. Plus with more cash at your disposal, you’ll have access to opportunities your competitors won’t, giving your brand the upper hand.
- Avoid lost sales and dissatisfied customers: Few things are more frustrating than going out of stock because your cash is tied up. But keeping tabs on your CCC can help keep the orders flowing, the product rankings high, and the customers happy.
- Build great credit: A healthy CCC means no more defaulting on payments or going over your credit limit. Since your utilization will be lower and you can repay sooner, you’ll be in a position to improve your credit rating and secure better funding options.
Calculate Your Cash Conversion Cycle with 3 Essential Metrics
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:
- Days in Inventory Outstanding (DIO) — the average number of days before the stock is sold.
- Days Sales Outstanding (DSO) — how quickly credit sales can turn into money.
- Days Payable Outstanding (DPO) — how long it takes a company to clear its accounts payable.
Here are the formulas:
- DIO: *Average Inventory / Cost of Goods Sold over the period x Number of days in the period
*Note: Average Inventory = Beginning Inventory + Ending Inventory / 2
- DSO: Accounts Receivable / Total Credit Sales x Days in the period
- DPO: Accounts Payable x Number of days in the period / Cost of Goods Sold
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:
- DIO: $15,000 / $5,000 x 30 days = 90
- DSO: $35,000 / $29,000 x 30 days = 36.2
- DPO: $8,000 / $5,000 x 30 days = 48
- CCC: 90 + 36.2 – 48 = 78.2 days
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.
How One Online Retailer Used a Negative Cash Conversion Cycle to Reach $1.3 Billion
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 😉).
Why a Negative Cash Conversion Cycle is never a bad thing: A negative cash conversion cycle is when it takes more time to pay your obligations than it does to sell stock and get your cash back into your account.
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:
- Run presales on entire collections to boost accounts receivable.
- Offer discounts and promotions to shoppers who pay in advance, e.g, on annual subscriptions.
- Reduce the amount of inventory you hold.
- Dropship items (especially seasonal products).
- Extend your supplier payment periods so you can hang onto cash longer.
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.
What Else Can You Do to Improve Your CCC?
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.
Audit your payment and return terms
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.
Let suppliers fund your expansion
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.
Build a Cash Conversion Cycle that Helps You Win
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.