Ecommerce Cash Conversion Cycle: What You Need to Know
The cash conversion cycle (CCC) is a metric that measures the number of days a company takes to convert the stock and inventory investments they’ve made into revenue from sales. The point is to measure the time between your investment (in inventory) and your return on that investment (through sales). This measurement can give you a sense of the health of your business and help you measure risk.
It is important to use the cash conversion cycle since it allows your company to judge whether your general management and operations are efficient. It also provides insight into your reliance on certain third parties such as an inventory supplier for a certain product etc.
If the cash conversion cycle is shortening, this is a good sign as your business is leaving less and less cash tied up somewhere as you grow. Your cash conversion cycle could be shortening when your company is growing so fast that you’re outgrowing your former cycle, or when you have systematically implemented processes to shorten it, such as inventory management and demand forecasting.
It is a negative sign if the cash conversion cycle of your company is increasing or getting slower because it means more of your cash is being tied up for longer. The process could be getting slower as a result of supply chain or inventory challenges and cash tied up in inventory. It could also have to do with marketplaces such as Amazon having a slower turnaround rate with payment terms. It can take up to 60 days for you to receive a payout from your sales.
It is also important to consider that the cash conversion cycle will be different depending on the industry or area of business in which your organization operates.
How do you Calculate the Cash Conversion Cycle?
There are three main elements to the cash conversion cycle formula.
CCC = DIO + DSO – DPO.
Let us break this formula down to be more palatable.
The first element of the formula, DIO (Days of Inventory Outstanding), is a calculation made based on dividing the average inventory value by COGS (Cost of Goods Sold).
DIO = Average Inventory/COGS x 365 Days.
The second element of the formula, DSO (Days of Sales Outstanding), calculates the time taken to receive revenue taken from sales. This calculation is made based on dividing the Revenue per Day, by average accounts receivable. The lower the DSO, the better, as it demonstrates the ability of the company to collect revenue in a short period of time.
DSO = Revenue Per Day/Average Accounts Receivable.
The final element of the formula, DPO (Days of Payables Outstanding), focuses on the amount of capital owed to the company’s suppliers for the stock/product they have purchased from them. This is calculated by dividing the average accounts payable by the cost of goods sold (COGS).
The higher the DPO, the longer the company is able to hold on to its money, which can allow for further investment potential.
DPO = Average Accounts Payable/COGS.
What are the Benefits of the Cash Conversion Cycle for Ecommerce?
It is beneficial to monitor the cash conversion cycle as a way of measuring overall performance in terms of cash flow, and the length of time it takes the company to convert product to cash with each cycle. It can also be used as a basis for setting KPIs for the expansion and improvement of an organization, as the cash conversion cycle can be used as a benchmark figure for future cash conversion targets.
Additionally, many suppliers will offer incentives to the debtors for faster conversion times in the form of discounts on future purchases or lessen the amount payable for early payment. These incentives can then free up funds for the ecommerce business to invest in different areas such as staff, marketing, or new product lines
For an ecommerce company, achieving a faster conversion rate can improve their relationship with suppliers. Ultimately, the more you approach them for restocking, the more sales they make. This can lead to further incentives offered to the company for paying bills sooner. You may get offered discounts in the future, or be given longer payment terms, and the ecommerce business could gain an edge over competitors in the long term.
By keeping track of and, where possible, streamlining the speed of your cash conversion cycle, you will also see an improvement in customer satisfaction and reviews. This is due to the fact that the longer the stock remains with the supplier, in warehouses, etc, the higher the possibility of product spoilage and damage.
So What are the Issues with the Cash Conversion Cycle?
One issue with the cycle is that, surprisingly, it can breed complacency. While it is good for measuring the viability of operations and the liquidity level of the business through measuring payable clearance times, it does not actually account for the general efficiency of the business in all departments. A short CCC is interpreted by many managers as the smooth running of the entire company, when in reality other areas can become neglected, leading to wider issues further down the line.
In reference to the earlier advantage of freeing up funds, the downside to this is that an organization may become too invested in making the cash conversion cycle as short as possible, for example by speeding up the round of inventory, which is a poor business strategy. As seen in the recent supply chain crisis, sometimes having a backup of stock is an advantage. If your supply chain dries up, you need to be able to fulfill orders while you search for a new source. A lack of inventory means a lack of sales, leaving you no funds to continue purchasing inventory.
Also, the funds saved from discounts will be used to pay suppliers’ existing payables faster, with little regard for other areas of the business that may be in more need of cash flow.
A negative cash conversion cycle is another challenge. In short, this means that it takes longer for you to pay your suppliers than it takes for you to sell your products. In short, a negative cash conversion cycle means your suppliers are financing your business. This is risky because if you can’t make your payments due to a lack of sales, you could lose your business.
How to Improve Your Cash Conversion Cycle
Focusing on inventory management and how you purchase, manage, market, and sell is the way to improve your CCC. The challenge, however, is that some of these steps require considerable changes within your business. You might need to invest a considerable amount into your marketing efforts, or change branding. You might switch suppliers, or logistics approach, or look to buy larger quantities of inventory. However, all of this requires capital.
There are multiple different avenues you can explore when looking for capital, in order to improve your cash conversion cycle. Most conventional approaches won’t work in the ecommerce industry because banks see the space as risky and most lending options will want the founder to act as a guarantor.
This is where capital advances can help. Capital advances provide cash balance for investment into areas such as inventory replenishment in order to maximize sales and profit without having to wait for ecommerce payouts. They also allow you to scale your business at a much faster rate, as you are not missing out on profits due to a lack of cash flow.
The best cash advance services will allow you to use the funding received how you please. This means you may invest the capital into any aspect of your business you see fit, including the cash conversion cycle, allowing for the rapid growth of your ecommerce business. At Yardline, we focus on simultaneously streamlining and enhancing this service. We pride ourselves on our innovative and unique approach to capital advances. Not only do we provide you with capital allowing you to scale, but we also work with you to understand exactly what you need to do to grow your business to be successful and sustainable.
We believe that funding is only half of the solution, with the other half residing within the personal support and ecommerce expertise provided by our Seller Success Team.
If this sounds like a good fit for you and your business, contact Yardline today for a conversation about exactly how we can help you!