With eCommerce flourishing and online stores amassing over 2 billion shoppers in the past few years. If you're selling on Amazon or on your own website, more than likely you’re enjoying the success of these sales. However, in order to keep up with demand and continue to scale, there is one concept sellers must pay close attention to: your cash conversion cycle.
At the core of any cash-related optimization is the concept of the cash conversion cycle. Understanding and mastering your cash cycle can help you determine when is the right time to purchase more inventory, invest in new products or even scale into a whole new market.
The cash conversion cycle is the time that it takes you to convert cash that is bound in inventory to cash inflow from the realized sales of the merchandise. Ideally, this is negative (i.e. you get paid by your customers before you pay for the inventory) - this is hard to achieve on Amazon though. Nonetheless the various ways of optimizing financing always go back to the idea that you minimize the amount of cash that is bound in inventory. This allows you to scale faster without making the amount of bound capital a constraint for your growth.
Let’s take a simple example:
You spent $160,000 on inventory today. The merchandise arrives at the warehouse in 30 days. Inventory is sold within two weeks by day 45. Amazon pays you after a settlement period of 14 days on day 60. You have now converted your $160,000 inventory investment into $200,000 realized cash (net sales minus FBA fees, Amazon commission and advertising costs). At this point you can invest into new inventory and start the cycle again. On an annual basis you would generate $1.2M in sales through this cycle.
In this way you’d have 6 cash cycles in a given year.
Let’s assume you were able to optimize your cash flow through financing options such as revenue-based financing or merchant cash advance, to bring the conversion cycle down to 45 days. At this point you’d be able to fit 8 (instead of 6) conversion cycles into the year.
Let’s assume you keep costs and revenues flat at the same pace: With the added two cycles you’d be increasing your sales by 33% from $1.2M to $1.6M, profit would increase from $240,000 to $320,000.
We can also look at the growth scenario:
The brand starts on the same level as in the previous scenario by managing a consistent 25% growth each month. In that case the added 2 cash cycles translate into $1.7M of additional sales, $790,000 of additional profit - overall an 80% increase compared to the 6-cycle year.
A healthy cash conversion cycle can be a pivotal growth lever for your business. By maintaining enough cash flow to fund new projects, while keeping your operations afloat, can save you money and time. With enough cash to cover new ground faster than your competitors, you’ll become a leader in your niche in no time.
Various financing options exist that help reduce the cash conversion cycle - they all come with specific upside opportunities, fee structures and risk profiles. To compare your options and understand your eligibility, learn more about our Fund my Brand offering here.
PS: And if your a formula geek, you’ll like this view of the cash conversion cycle: