By Jordan Lau, Analyst

What is Cash Conversion?

The Cash Conversion Cycle (CCC) is the amount of time between a company spending cash on inventory and receiving cash for the sale of inventory. The lower the number is, the better it is for the company as this means it has taken the company a shorter amount of time to convert working capital into cash. CCC is an excellent measure of a company’s efficiency when it comes to operational cash management, and is calculated below.

Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payable Outstanding (DPO) = CCC

Amazon’s Conversion Machine

Amazon is one of the few companies who have a negative conversion cycle, meaning they are able to receive payment before paying their suppliers. Having a negative CCC allows Amazon to borrow from its suppliers to finance its operations, interest-free. This also frees up available cash that can be used for the company’s growth initiatives.  Compared to other retail giants such as Walmart and Costco, Amazon have a significantly lower cash conversion cycle. So how have they been able to achieve this?

Walmart and Costco are more effective at moving inventory than Amazon, and are also faster at receiving payment from their customers. What sets Amazon’s CCC apart is their ability to delay payments to their suppliers. Amazon takes significantly longer to pay its suppliers and is able to do because of their diverse marketplace. Amazon’s product range is limitless as their digital platform renders the cost of adding items close to zero. A company like Walmart has to face these costs, therefore, will have a smaller product range coming from a selective group of suppliers. Amazon, however, does not care what the product they sell or who the product came from, just as long as it sells. In essence, Walmart selling 10 million units of one product is equivalent to Amazon selling one unit of 10 million products. The importance of one supplier is significantly less to Amazon than it is to Walmart, giving Amazon more leverage during contract negotiations with its suppliers. The company’s ability to strong-arm its suppliers into favorable concessions is the primary reason why they have a negative CCC, and thereby allows them to consistently generate positive cash flows despite having a relatively small net margin.
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