Ecommerce is a cash-intensive business. Anyone who runs an online operation knows this to be true. You must constantly pay suppliers for inventory, sell these products to your customers, and then use your proceeds to buy more goods before running out of stock.
A problem many owners encounter–especially with a brand that is growing rapidly–is a cash balance depleting to zero before you are able to receive payment for the items you have sold. Your money essentially becomes stuck, and you need to continually invest more resources in order to stay afloat.
It is therefore mission critical that you learn how to optimize your cash flow. If you are able to develop strategies to achieve a cash conversion cycle that is negative–which we will dive into throughout the article that follows–you can ensure that your business continues to run in an efficient, effective, and fiscally-healthy fashion.
What is the Cash Conversion Cycle?
The cash conversion cycle (CCC) calculates how long it takes for a company to turn the funds it has invested (say, into inventory) back into actual capital. Think of it as a measure of how many days pass by from when you pay for an order placed with your supplier to when the proceeds from those goods sit in your bank account.
This is a metric that you should diligently keep tabs on, particularly if you run an ecommerce store and are in the business of selling physical products.
Here is a formula to better understand the nuances of the cash conversion cycle:
It is basically how long it takes to sell your inventory, plus how long it takes to receive payments from your customers, minus the length of time it takes to pay your suppliers.
To provide a hypothetical example, imagine your cash conversion cycle is 100 days and you are selling $2k/day in products. That means that $200k worth of cash is tied up in working capital. Should your sales increase to $3k/day, the amount “stuck” would increase to $300k, and you would need to invest $100k into the business to fill the gap and keep it chugging along smoothly.
Gymshark–the popular fitness apparel and accessories brand–has a cash conversion cycle of -101 days based on a calculation of their days of inventory outstanding, sales outstanding, and payables outstanding. This negative cash conversion cycle means that their suppliers are in essence funding their operations, and no additional capital needs to be pumped into the business to purchase inventory as they scale.
This state of operational efficiency can be achieved by receiving payments for goods before your suppliers need to be paid for materials. In effect, shortening the length of time it takes to acquire proceeds, in combination with deferring required payments to vendors as long as possible.
Let’s explain how this can occur, and what levers you can pull to increase your cash balance while your sales continue to accelerate.
Days Inventory Outstanding (DIO)
Days Inventory Outstanding (DIO) is, on average, the number of days it takes to sell through your stockpile of inventory.
The less time you are holding onto goods, and products lie sitting unsold in your warehouse, the smaller your DIO is.
This is a net benefit for your cash conversion cycle. It means your business is running with greater efficiency, and you are able to liquidate working capital more quickly. You can use these funds to purchase more inventory, without as much of a concern that you will drain the cash you have on hand.
Days Sales Outstanding (DSO)
Days Sales Outstanding (DSO) calculates how long it takes to collect payment for goods sold to your customers. A lower DSO expedites the cash flow into your business, which is what you want.
One method to keep your DSO as close to zero as possible is to require immediate payment from your shoppers. Payment terms of net 15 or 30 days lengthens your DSO, and keeps funds locked up for longer.
Days Payables Outstanding (DPO)
Days Payables Outstanding (DPO) equates to the period of time (average number of days) it takes for your company to pay its bills to vendors and suppliers.
The more you are able to extend when you have to pay your bills, the shorter your cash conversion cycle will be. Longer payment terms mean you can hold onto cash for longer after you sell your inventory.
Why Cash Conversion Cycle Matters
It is crucial to monitor your cash conversion cycle for a number of reasons. If you ever intend to sell your company, or receive outside investments of any kind, potential buyers, lenders, and investors will look to your cash conversion cycle as a key indicator of its soundness.
The more liquidity your company has, the less obstacles there will be in paying back a loan or meeting other financial obligations. You should therefore seek to establish a cash conversion cycle that instills confidence in the management of your business.
Your cash conversion cycle also matters because it can be a factor that your suppliers use to determine whether or not to extend credit that you might need. If your funds are constantly tied up and your business lacks sufficient cash flow, your suppliers may be concerned–rightfully so–that you won’t be able to pay them back within a satisfactory time frame. This could place your ability to source inventory at risk.
You should also be mindful of what your cash conversion cycle is saying about your business as a whole. The data rarely lies. If your cash conversion cycle is unacceptably high, it could be a sign of poor demand for your products, declining interest in the niche you are selling in, or mismanagement. Use analysis of your cash conversion cycle as an opportunity to make necessary pivots that can set your business back on the right path.
How to Improve Cash Conversion Cycle (Create a Negative Cash Conversion Cycle)
As we’ve established previously, your cash conversion cycle hinges on how long it takes to sell your inventory, plus how long it takes to receive payments, minus the length of time it takes to pay your bills. Based on this formula, each one of these variables can be worked on–independently or in combination–to achieve a more advantageous cash flow for your company and ideally, a negative cash conversion cycle.
Adjustments to your promotional efforts can be made in order to sell inventory quicker. Enhancing your online presence and investing in better marketing materials can drum up consumer demand that helps your products fly off the metaphorical shelves. You can also make the decision to eliminate slow-moving SKUs from your catalog. This will free up resources and unblock your sales volume.
To receive deposits sooner, you can require immediate payment from your customers. You might also think about putting in place stricter protocols for collecting invoices. This will decrease the processing time of your payments and the period in which your funds are in limbo.
Extending the time you take to pay vendors and suppliers–which gives you more opportunity to generate cash flow and hold onto your funds before needing to make payments–is a crucial component of the cash conversion cycle. You might therefore be well served to defer payment to suppliers for as long as possible without incurring any penalties.
Negotiate Terms with Your Suppliers
There are many reasons to have a strong relationship with your suppliers, not least of which is the ability this can have to positively affect your cash conversion cycle.
Should you ask to extend your payment terms, and your suppliers comply, this can relieve much of your pressure related to cash flow.
Most suppliers that you have built a trustworthy relationship with, and have conducted business with on a consistent basis, should be amenable to a modification in payment terms. However, if they do push back, you can always offer to pay an additional fee of 1-2% for an extension. This can grant you the breathing room needed to achieve a more balanced payment schedule.
Finance Purchase Orders
If you have a cash flow shortage but still want to be able to complete an abundance of orders coming in, there are a variety of options you can use to sustain your operation and make this possible.
Purchase order financing gives you the ability to pay your suppliers for the products you need to fulfill outstanding customer orders.
Plastiq is a payment processing platform that allows you to access working capital and pay bills to vendors with less friction. Using Plastiq lets you seamlessly access short-term financing directly through the system. You can also use Plastiq to extend the time you have to pay large expenses by up to 90 days. This will directly increase your days payables outstanding and lower your cash conversion cycle.
Parker is an ecommerce-specific financial solution that can also be used to extend payment terms with your suppliers. Parker’s offering of cards allows you to pay your expenses and have more flexible payment terms (up to 60 days) and higher spending limits than traditional alternatives.
Other options you can use include paying purchase orders with Settle.co, Kickfurther, or Floatpay. These solutions can give you another 60-120 days to fulfill your obligations with suppliers, and make it so that your invoices are paid up front, while you pay this back as your products sell.
Ask Advertising and Tech Partners for Net 30 Payment Terms
Should you have a good payment history, you can ask to be given net 30 payment terms with your advertising and tech partners. With invoices classified as net 30, this means that you can pay up to 30 calendar days after you’ve been billed.
This is essentially a form of trade credit that you’re being extended, and when paid with the flexibility that Parker provides, you can extend the terms even further. This can be leveraged to lengthen your days payable outstanding, which will have the effect of reducing your cash conversion cycle.
Revenue-based financing allows you to receive capital upfront in exchange for a percentage of ongoing sales. It is an alternative to debt and equity-based funding, because no ownership in your business is taken, and no personal guarantees are involved. Financing is put forth in exchange for a portion of future earnings.
Using services like Wayflyer, Outfund, and Clearco can enable you to tap into the power of revenue-based financing. If approved and given an offer from one of these platforms, this can free up the amount of cash available to your business. You will have resources available instantly, which you will be able to then funnel toward purchasing inventory, and pay back in accordance with monthly sales revenue.
Launching a pre-order sale is an easy and effective way to collect cash upfront before officially paying for inventory. It can also allow you to better gauge demand.
The main benefit of a pre-sale is that there is no expectation from customers that they will be receiving their items right away, so you can take unlimited orders without needing to fulfill them immediately.
You can then use this data to properly forecast how much inventory you will require without the risk of over-ordering. At the same time, you can use the funds you have already received throughout the pre-order process.
Inventory that sits around unsold presents a number of complications from a cash management perspective. It continues to lock up funds in goods that are not returning any profit, while at the same time taking up valuable storage space.
It is therefore crucial that you know when to cut your losses and eliminate any slow-moving SKUs from your storefront. Liquidating stale inventory is a necessary step toward ensuring that your operations continue to move along, and can allow you to re-focus on the goal of converting inventory as rapidly as possible.
In the future, you can project inventory turnaround more accurately (using a tool like Inventory Planner) in order to lower your days of inventory outstanding.
How you manage your cash conversion cycle is a barometer of your competency as an ecommerce owner. Its length can mean the difference between prosperity and bankruptcy for your business.
Reducing your cash conversion cycle can lead to a shorter period of time in which you need to finance your accounts receivable and inventory. This can increase your liquidity and ability to put capital behind decisions that propel your business forward. Getting to a negative cash conversion cycle is even better, and can allow you to achieve a more advantageous state of cash flow.
All of the strategies outlined in this article, when working in sync, can ultimately help you achieve a favorable balance. They can be used to yield a much-needed boost, and enable you to better manage the underlying financial well-being of your business.