Managing cash flow is one of the most complex parts of running an online business, and it's getting harder in today's economy, with inflation and problems in the supply chain.
As an online seller, you're likely familiar with the constant juggling of inventory management, shipping costs, and marketing expenses, all while keeping a close eye on your available cash.
Even the most promising business can quickly fail without a healthy cash flow.
That's why it's crucial to deeply understand your business's financial operations and track key metrics.
In this article, we'll look at the Amazon cash conversion cycle and how it can help you better understand your business's cash flow.
By the end of this guide, you'll have a solid understanding of how to use the CCC to overcome cash flow issues and keep your business thriving.
The cash conversion cycle (CCC) is a metric that expresses how long it takes you to convert your investments in inventory and other resources into cash flows from sales, measured in days.
CCC considers how long it takes you to sell your inventory, how long it takes to collect receivables, and how long it takes to pay your obligations.
The CCC is one of several quantitative indicators used to assess a company's operations and managerial efficiency.
A trend of falling or stable CCC levels across various periods is a healthy sign. However, growing values should prompt more study and analysis based on other considerations.
Remember that CCC only applies to specific industries that rely on inventory management and related processes.
Businesses such as eBay and Amazon have negative CCCs.
These companies, however, do not pay the sellers immediately after the sale but rather on a monthly or threshold-based payment cycle.
Because this strategy permits them to keep their cash for extended periods, they frequently have a negative CCC.
As a result, it is an interest-free method of financing operations through supplier borrowing.
Furthermore, suppose the goods are immediately supplied to the consumer by the third-party seller. In that case, the online retailer never retains any inventory in-house.
Overall, it allows Amazon to generate cash quickly, maintain a high level of liquidity, manage its working capital efficiently, and respond to market conditions more effectively.
Amazon's average cash conversion cycle was 14.02 from December 31st, 2009, to June 30th, 2022, compared to an industry average of 270.27.
The Amazon cash conversion cycle is negative because they sell merchandise rapidly (low Days inventory), receive money immediately for most sales (low Days Receivables), and defer payment to suppliers for as long as feasible (high Days Payables).
Calculating the Amazon cash conversion cycle (CCC) involves three main components:
The formula for calculating the CCC is as follows:
CCC = DIO + DSO – DPO
Here's how to calculate each component:
1. DIO = Days Inventory Outstanding (average inventory/cost of goods sold x number of days)
2. DSO = Days Sales Outstanding (accounts receivable x number of days/total credit sales)
3. DPO = Days Payable Outstanding (accounts payable x number of days/cost of goods sold)
DIO and DSO in the CCC formula represent your cash inflow, whereas DPO represents your cash outflow.
It demonstrates how you transform cash into inventory (accounts payable), sales (accounts receivable), and back into cash on hand.
The most common question regarding CCC is whether a high or low cash conversion cycle is preferable.
You should aim for a shorter or lower CCC because it signifies that a business has less time between purchasing inventory, selling items, and earning cash.
A shorter CCC means that you have easy acess to cash, which you can use to buy more inventory and, as a result, make more sales.
In contrast, if you have a high CCC, it may take a long time to get money from customers or be unable to predict the demand for your products.
A high or rising CCC may also indicate that your company is not making the most use of its short-term assets.
Thus, the critical parts of CCC are inventory management, payment collection, and bill payables. Any one of these issues can lead to a company's cash flow being insufficient, for example:
As a result, CCC displays the efficiency with which the company's management operates.
As an Amazon seller, you can focus on any of the CCC's three components to enhance (lower) it. Increasing DPO, decreasing DSO, or decreasing DIO will all lower the CCC:
1. Use accurate demand forecasting to ensure you have the right amount of inventory, avoid stockouts, and keep extra inventory to a minimum.
2. Use effective supply chain management to reduce lead times, improve delivery times, and speed up the flow of goods through the supply chain.
3. Streamline order fulfillment to reduce the time it takes to get products to customers.
4. Leverage efficient accounts receivable management by collecting payments from customers more quickly
But it's important to remember that a company's cash conversion cycle is just one part of working with your suppliers and customers.
Here are some of the key advantages of a shorter CCC:
1. Improved liquidity, as you have more cash on hand to meet your short-term financial obligations.
2. Better working capital management to fund your day-to-day operations. By improving how you manage your inventory and speeding up how you get paid, you can free up cash to invest in growth opportunities.
3. Increased efficiency in the company's supply chain, resulting in cost savings and other operational benefits.
4. Competitive advantage, as it allows you to respond more quickly to changes in customer demand and market conditions. It also lets you negotiate better payment terms with suppliers, as you have a strong cash position.
In contrast to brick-and-mortar stores, which typically receive payment at the time of sale and are thus immune to cash flow gaps, marketplace sellers, in particular, often have to wait anywhere from a few days to a couple of months after making a sale before they receive payment.
Most business owners know they can only keep going like this for a while, so they look for ways to get money to help close the gap.
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Here are some ways the longer Amazon Cash conversion cycle can affect your financial performance:
1. Reduced liquidity- In extreme cases, a longer CCC can lead to cash flow problems, impacting your ability to invest in growth opportunities or pay bills.
2. Increased working capital can lead to increased borrowing costs, as you may need to take on more debt to finance your operations.
Higher borrowing costs can affect the company's profits and reduce shareholder returns.
3. Higher storage costs can reduce the company's profits, as it must spend more on overhead expenses.
4. Reduced Profit Margins –The longer it takes to convert inventory into cash, the longer it takes to recoup the costs of producing and storing those products. As a result, you may need to sell products at lower prices to move inventory, which can reduce profit margins.
5. Competitive Disadvantage – If your competitors have shorter CCCs than you, they may be able to respond more quickly to changes in customer demand or market conditions, resulting in lost sales opportunities and reduced market share.
The Amazon cash conversion cycle is an essential metric for online sellers because it measures the time it takes to convert inventory into cash.
A shorter CCC means that a seller can turn over their inventory quickly and collect payment faster, which can help increase cash flow and profitability.
On the other hand, a longer CCC means holding onto the stock for a long time before you sell it and receive payment, which can tie up cash and reduce profitability.
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Amazon's cash conversion cycle is vital because it provides insight into the company's working capital management and efficiency.
Amazon's cash conversion cycle can impact sellers on its platform, particularly those who rely on Amazon's Fulfillment by Amazon (FBA) service. A longer CCC can impact their cash flow and profitability.
Amazon sellers can improve their cash conversion cycle by optimizing inventory management practices, negotiating favorable payment terms with suppliers, and improving their accounts receivable processes. Additionally, sellers can leverage technology and data analytics to improve their forecasting and demand planning, which can help reduce excess inventory.