How fast can you turn your inventory into sales?

Did you know that your cash conversion cycle (CCC) can say more about your online and Shopify ecommerce brand’s health than the $XX millions you made in sales?

Here’s why:

Many ecommerce founders have grown seven-figure-a-year brands with a good product and a healthy dose of grit, but have ultimately failed when all the revenue needed to be funneled into paying back debt.

With strong cash management through ecommerce accounting and ecommerce bookkeeping, you can bootstrap your brand, or if you need financing, you can limit it to the bare minimum. This means more dollars in your pocket (today and if you exit in the future).

So, what’s the key to getting there?

The lower the CCC, the better (best case scenario: a negative CCC).

Cash Conversion Cycle Defined:‍

The CCC is a critical financial metric that assesses how efficiently a business converts its inventory into cash. The CCC helps e-commerce brands understand the timeline of cash outflow (purchasing inventory) and cash inflow (sales and collections), and it provides insights into potential cash flow gaps that might necessitate external financing.

Each component of the CCC sheds light on different aspects of cash management within the business:

• Days Inventory Outstanding (DIO): This metric helps track how long inventory is held before it is sold. Optimizing DIO means balancing inventory availability to meet demand without holding excess stock that ties up cash and incurs carrying costs.
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• Days Sales Outstanding (DSO): Assesses the time it takes to collect payments after a sale.
  Ecommerce brands that sell exclusively DTC generally get paid almost immediately after selling their products. In these cases, the cash conversion cycle really only takes into account purchase of inventory (as an account payable when you pay for inventory, and how long it takes you to sell it. As in, DIO and DPO).
  However, this will apply to those selling wholesale or offering net terms to B2B customers.‍
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• Days Payables Outstanding (DPO): DPO reflects the average time taken to pay suppliers. Extending DPO can improve cash flow, allowing businesses to use their cash for longer before paying suppliers.
  However, be careful here, as extending payables too far can strain supplier relationships.

A Negative Cash Conversion Cycle is ideal.

Negative CCC signifies that the business receives payments for its products before it has to pay suppliers. This setup essentially uses customer payments to fund ongoing operations, as a form of trade credit, without needing additional financing.

Achieving a negative CCC involves:

• Extending DPO while maintaining positive supplier relationships.
• Lowering DSO by ensuring efficient collections.
• Improving DIO to achieve faster turnover.

For example, a business might negotiate 60-day payment terms with suppliers, achieve a 15-day inventory turnover, and collect receivables in 10 days, resulting in a negative CCC.

In this setup, the business effectively uses supplier credit to fund operations.

Here’s our completely obvious 4-point plan to shorten your CCC:

1. Calculate your CCC

CCC = Days of Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) - Days Payables Outstanding (DPO)

• DIO: The time it takes to sell your inventory 
• DSO: The time it takes to collect receivables
• DPO: The time you have before paying your bills
  

2. Improve inventory turnover

To improve DIO you need to:

• Improve the sales process and marketing.
• Improve the customer experience.
• Minimize SKU count to simplify demand planning.
• Optimize distribution and lead times.
• Demand Forecasting: Use data analytics to accurately predict demand and reduce excess stock.
• Inventory Management Tools: Inventory management software can improve reordering and prevent overstocking.
• Product Bundling: Bundle slower-moving products with popular items to speed up inventory turnover.

3. Get customers to pay you faster

Find the sweet spot between receiving your money quicker and keeping your customers from trying alternatives.

• Offer more payment options.
• Tighten up invoicing.
• Communicate clear payment terms.
• Offer Payment Incentives: Providing discounts for early payments can encourage customers to pay faster.
• Credit Terms Review: Regularly evaluate credit terms for wholesale or B2B customers to ensure they are not unnecessarily long.
• Use Factoring Services: Factoring can be an effective solution to get immediate cash for accounts receivable, improving cash flow at the expense of a small fee.

4) Pay your suppliers later

Not only can you receive your money quicker, but you can also arrange to pay your suppliers later.

• Don’t pay suppliers unnecessarily early.
• Use a credit card or financing option with longer payment terms.
• Leverage Scale for Favorable Terms (and renegotiate terms): Larger orders or longer partnerships may give businesses the leverage needed to negotiate extended terms.
• Consider Dynamic Discounting: Consider paying suppliers early if excess cash is available to secure discounts, which can lower overall costs.

When private equity firms or investors acquire e-commerce companies, the CCC is often a primary focus (after firing excess employees).

By optimizing CCC, investors can unlock trapped cash, reduce financing costs, and improve the company's overall profitability. Improving CCC can free up working capital, making the business more attractive for further investment or resale.

Now, you don’t need to wait for a private equity firm to buy out your business to optimize your cash conversion cycle. Using accurate real-time financials and configuring and managing your metrics is key to keeping your finger on the pulse of your CCC and lowering it towards the North Star of e-commerce finance - the Negative CCC. and with it, a healthier business. And perhaps better valuations.