We analyze how companies at every stage optimize the cash conversion cycle
- The cash conversion cycle measures how effectively a company can collect cash, sell inventory, and pay suppliers.
- Companies that master the cash conversion cycle are able to effectively finance operations and fund growth with their customer’s money.
- This report looks at the metrics for thousands of public companies and identities 5 industries and related companies that have favorable cash conversion dynamics and opportunities within those industries moving forward.
- The industries and companies we identified: Restaurants (Chipotle), Entertainment (AMC), Printing (Cimpress), Personal Retail Products (Coty), and Business Services (Autodesk).
- Our report includes an examination of the Saas firm Buffer, highlighting cash cycle best practices for early-stage tech software companies.
10 Minute Read
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In 2014, the Harvard Business Review published an oft-cited article titled “At Amazon, It’s All About Cash Flow.” The article set out to address the sentiment that Amazon “didn’t make any profit.”
In analyzing Amazon, the article argues that observers should focus on the e-commerce company’s free cash flow rather than its net profit, which doesn’t properly take into account investments in capital goods.
The article continues by identifying the best metric to measure a company’s ability to generate cash: the cash conversion cycle (CCC).
“…the key metric of a company’s cash-generating prowess is the cash conversion cycle, which is days of inventory plus days sales outstanding (how long it takes your customers to pay you, basically), minus how many days it takes you to pay your suppliers [days payable outstanding].
Super-efficient retailers such as Walmart and Costco have been able to bring their CCC down to the single digits. That’s impressive. But at Amazon last year, the CCC was negative 30.6 days.
In Amazon’s case, all this cash is being used to finance the company’s continued explosive growth. The company doesn’t need to borrow, it doesn’t need to issue stock. It can just keep spending its own cash to attack new sectors and upgrade its offerings.”
Here is the breakdown for Amazon’s cash conversion cycle (CCC) in 2019:
The key lever for Amazon is in how long it takes to pay its suppliers (DPO) relative to how quickly the company can unload inventory (DIO) and collect customer cash cash (DSO).
It takes Amazon 24 days to collect cash, 33 days to unload inventory and — impressively — 76 days before it pays its suppliers. This leaves the firm with a cash conversion cycle (CCC) of negative 19 days. Effectively, the company is able to finance and grow its business using its customers’ money.
As a point of comparison, Walmart had a CCC of positive 2 days in 2019; while this figure is quite efficient, Walmart effectively has its cash tied up for 2 days while its inventory turns to cash to be collected.
Clearly, Amazon’s incredible market power and scale allow it to press for the most advantageous supplier terms.
While the model is monstrously hard to duplicate, the broader lesson remains. In the 2020 business environment where “cash is king” is more sexy than “growth at all costs,” the ability to get customers’ cash in the door before paying suppliers is a major competitive advantage.
Back to the HBR article:
“…So if you have a business where your customers pay you quickly, you manage your inventory well, and you’re able to take your time in paying your suppliers, your free cash flow can be consistently positive even when your net income is not.
The rest of this report draws data from thousands of public companies to identify 5 industries (and related companies) that have favorable CCC dynamics. They include: Restaurants (Chipotle), Entertainment (AMC), Printing (Cimpress), Personal Retail Products (Coty), and Business Services (Autodesk).
We break down the aforementioned companies within each industry to show how they achieve a negative CCC. Finally, we draw best practices from each example and highlight future opportunities.
Industries With Favorable CCCs Include Restaurants, Printing, Entertainment, Business Services, and Personal Products
Digging further into the Amazon example, one of the key benefits of a negative CCC is that a company can minimize short-term debt financing and the sale of equity to finance its business.
Interest payments are a drain on resources while selling equity early can prove very costly down the line.
Optimizing the CCC is one way of minimizing (or eliminating) those costs.
Certain industries have structures that are favorable for a lower CCC.
A 2017 research paper from Baolin Wang at the University of Florida looked at the correlation between US stock performance and CCCs. The paper finds that a portfolio going long on low CCC companies and short on high CCC businesses produced excess returns.
However, what is of greater interest for this report is Wang’s research into the average CCC of different industries. The table below shows the average CCC for US stocks on the NYSE, AMEX and NASDAQ by industry.
Source: Journal of Financial Economics
Keeping in mind that lower average CCCs are generally more favorable, we identified 5 industries to take a closer look at: 1) restaurants; 2) entertainment; 3) business services; 4) printing; 5) retail.
Other low CCC industries such as communications, transportation, utilities, coal, and healthcare are more regulated and not as easy to navigate for those looking to launch new businesses.
From here, we used the financial analytics service Morningstar to identify companies with a negative CCC within each industry. Finally, we look at each company’s individual filings to help explain how they achieve their cash cycle position and what opportunities there may be moving forward in each industry.
Restaurants: Chipotle Mexican Grill
The structure of the restaurant industry — particularly fast casual establishments — lends itself well to low (or negative) CCCs.
Chipotle — the Mexican fast-casual chain — is a well-known leader in the category. The company’s 10Q filing illustrates how it is able to collect cash quickly, has few inventory requirements, and can extend supplier terms:
- “We have not required significant working capital because customers generally pay using cash or credit and debit cards and because our operations do not require significant receivables…” (DSO)
- …”nor do they require significant inventories due, in part, to our use of various fresh ingredients.” (DIO)
- “In addition, we generally have the right to pay for the purchase of food, beverage and supplies sometime after the receipt of those items, generally within ten days, thereby reducing the need for incremental working capital to support our growth.” (DPO)
Opportunity: Now, to be sure, the restaurant industry is typically low margin and highly competitive. However, there are definitely opportunities to grow operations via customer sales without significant debt or equity financing needs.
For those looking to step into the food and beverage space, Restaurant Business publishes an annual “Future 50” list of the fastest growing food concepts in America for restaurants making $25m to $50m.
The table below highlights the top 20 concepts from the list and notes whether the brand has franchising opportunities. The only concepts that have multiple entries on the list are fast-casual pizza and BBQ.
Other interesting concepts include fast-casual Greek, “Taiwanese Starbucks” and artisanal biscuits.
Source: Restaurant Business
Entertainment: AMC Entertainment Holding
AMC is the largest movie chain theatre in the world. While the company’s public market performance has been subpar in recent years, the economics of AMC’s business highlights how entertainment firms can create a negative CCC. In AMC’s case, the ability to fund its business through its customer’s cash is referred to as “float”:
- “[AMC’s revenues] are primarily collected in cash, principally through box office admissions and food and beverage sales; [AMC] has an operating “float” which partially finances [its] operations, and which generally permits the company to maintain a smaller amount of working capital capacity.”
- “This float exists because admissions revenues are received in cash…” [DSO]
- “…while exhibition costs (primarily film rentals) are ordinarily paid to distributors from 20 to 45 days following receipt of box office admissions revenues.” [DPO]
Outside of movie theaters, a key example of the entertainment business model at work is live concerts. Tickets are sold many months in advance and the funds can then be put to use in creating the event.
But, as with anything, you’ll have the good and bad. In this case, a negative CCC can be the catalyst to create a 9-figure behemoth like Coachella or a generationally awful scam like the Fyre Festival.
Opportunity: An interesting trend to follow moving forward is the marriage of live entertainment and corporate marketing. Cvent — the meeting and events technology firm — does a great job of highlighting key trends around the idea that “meetings will become music festivals”:
- Per Billboard, millennials accounted for nearly 50% of the 32m people that attended the ~800 US music festivals.
- As millenials advance through corporate America, this demographic cohort will expect meetings and conventions to have a significant entertainment aspect.
- A notable example of “meeting as music festival” was a recent Forbes Under 30 Summit, which hosted 7k guests entertained by the artists Marshmello and Wiz Khalifa.
- As these type of events require large spaces, there’s an opportunity to reach out to utilize non-traditional live event venues (e.g., resorts, golf courses).
If executed correctly, the live entertainment / corporate marketing business is an opportunity to leverage the negative CCC dynamic and have customers finance a portion of events, supercharged by corporate money.
For entertainment / event options that more closely serve as substitutes for movie-going, a recent Gallup poll highlights some opportunities.
On average, Americans 18 or older went to a movie theater 5.3x in 2019. Below is a list of comparable leisure activities (and frequency):
- Library (10.5x a year)
- Live sporting events (4.7x)
- Live music or theatrical event (3.8x)
- National or historic park (3.7x)
- Museums (2.5x)
- A previous Trends article explored the opportunity around Digital Museums
Entertainment offerings built around these activities can all potentially leverage the negative CCC dynamic.
Cimpress — a $3B print company that operates many brands and is based in Ireland — does work for customizable and mass print, publishing, apparel, and signage.
The company’s main lever for its impressive cash conversion cycle (-19) is its ability to negotiate very favorable terms with the 100s of suppliers it works with. Cimpress is able to demand such terms as it is the hub that attracts the customer demand and, in many cases, is its suppliers’ largest partner.
From the company’s earnings transcript last summer:
- We’ve been able to negotiate with 200 or more suppliers, with a focus on working capital improvement and specifically payment terms to yield a $25 million improvement, which is a one-time improvement in our working capital leading to an increase in average days payable of 9 days. (DPO)
Opportunity: According to IBISWorld, the US digital print industry brings in annual revenue of about $11B and is forecast to grow at a steady 3% per annum through 2024. While the transition to more online media is a threat to the industry, it is somewhat offset by the growth in small business operations (single-digit employees) that require physical marketing materials.
From a CCC perspective, the print business is advantageous because the customer pays upfront. From the supplier side, there are many vendors to choose from, whether locally or online.
To receive the most favorable supplier terms, an online print business must create the platform to generate customer demand.
An example of such a platform is Cimpress’ brand Vistaprint.
Recreating a full 360 offering like Vistaprint is a quite a heavy lift but — according to Cimpress’ latest earnings transcript — there’s an opportunity to differentiate a print business by leveraging ML/AI-tools to auto-correct common print snafus:
- Misaligned folds and flaps on boxes
- Apparel mis-coloring
- Artwork improperly translated (e.g., intricate details off)
In an industry that otherwise has low barriers to entry, such a tech-enabled advantage is a significant differentiator. An online print offering that can ably solve these print issues would be able to attract sufficient customer demand that could be leveraged to secure favorable supplier terms.
Retail (Personal Products): Coty
Coty is a $9B beauty company that made a splash by acquiring 51% of Kylie Cosmetics.
Compared to the previous examples, the days outstanding for Coty’s sales, inventory, and payables are much longer.
As Coty is in the beauty business, its product is typically mass produced and can sit on shelves for a long time (with a DIO of 127 days). To offset the inventory holding costs, Coty has a DPO of 202 days.
In addition to its favorable supplier terms, Coty is able to achieve a negative CCC by keeping its DSO relatively low at 57 days. From the firm’s most recent 10Q, one of the levers Coty uses to achieve this is by selling 100s of millions of its receivables to various financial institutions through a process called factoring:
- “Cash and working capital management initiatives, including the…factoring of trade receivables from time-to-time, may also impact the timing of our operating cash flows.”
- “[Coty] entered into a factoring agreement with a financial institution, which allows for the transfer of receivables…in exchange for cash…Eligible trade receivables are purchased by the financial institution for cash at net invoice value less a factoring fee…[Coty] acts as collections agent for the financial institution and is responsible for the collection, and remittance to the financial institution.”
By factoring its receivables, Coty can better control the timing with which it collects cash (days instead of weeks or months).
Opportunity: To be clear, factoring can be pricey. The financing provides between 70-90% of the outstanding invoice while charging a processing fee and “per week factor” fee (for slow paying invoices) that can quickly add up.
However, there are also clear benefits to factoring:
- Speed up cash collection times
- Smooth cash flows
- Invoices serve as collateral
- Financing is easier to qualify for (bank loans require long credit and operating histories)
Factoring is available at banks but there are also a number of nimble digital offerings such as Blue Vine, Kabbage, and Fundbox.
Whether factoring is right for your business venture will depend on the context, but it’s definitely a good tool to deploy when looking to turn customer sales into cash for business needs.
Business Services: Autodesk
Autodesk is a $44B software company that provides design, modeling, and rendering applications for architects, engineers, construction, and product designers in media and entertainment.
At first glance, Autodesk’s CCC of negative 60 days is very impressive. From the firm’s latest earnings transcript, the key lever for its strong cash position is its SaaS business model:
- Over the last 12 months, we generated a record $972m of free cash flow, demonstrating the power of our subscription model and the strength of our products.
Autodesk’s customers subscribe to its product suite, often paying for a full year’s service in advance. The company collects that cash before having to pay out its main expenses in the form of tech workers and computing resources.
It should be noted that the traditional CCC calculation is less useful for software companies because these firms do not “hold inventory.” As inventory is a tie-up of cash, the traditional CCC calculation is skewed to look better than it really is.
To account for this, the SaaS investor Tom Tungunz highlights a software-oriented CCC calculation that substitutes in “sales cycle” for “DIO,” “accounts receivables (AR)” for “DSO,” and “accounts payable (AP)” for “DPO.”
Functionally, AR-DSO and AP-DPO are very similar.
The Sales Cycle-DIO comparison is a bit different.
The money outlay to acquire a customer (“sales cycles”) is comparable to the money outlay to stock physical goods (“inventory”). In both cases, cash is tied up until a transaction is complete (a subscription for software company; a product sale for a retailer).
Opportunity: While Autodesk’s CCC would be less robust with the software-oriented calculation, the attractiveness of the SaaS model for those looking to bootstrap a business with customer sales is undeniable.
Indiehacker’s interview with David Hauser (founder of the virtual phone system app, Grasshopper) speaks directly to the beneficial cash cycle of software-enabled businesses:
- Bootstrapping a business is always hard, and when you are doubling revenue each year it is critical there is enough cash to do this. We created a positive cash cycle where we collected revenue from customers via credit card payments well before we paid for the actual usage related to those payments. We extended payment terms and using credit.
Buffer: Cash Management for Bootstrapped Software Firms
Buffer is a popular platform of social media products and one of the most prominent remote-only software firms in the world. The company is known for its informative blog and commitment to full transparency, including a publicly available list of employee salaries.
From a cash management perspective, Buffer has been very open about its pivot from a VC-funded firm chasing growth to a bootstrapped entity carefully accounting for every dollar. Over the years, Buffer has rebounded from a cash crisis to a very strong cash position (the company targets a cash balance that can cover a minimum of 4-6 months of operating expenses).
This cash cushion allows the firm to be very deliberate in its growth initiatives, with a particular emphasis on setting strategy roadmaps based on annual budgets.
As such a visible leader in the bootstrap software community, we reached out to Buffer’s head of finance Caryn Hubbard in an effort to better understand what levers an early-stage software firm can use to optimize its cash cycle.
Promote Annual Subscription Prices
As a software firm, when a customer subscribes to Buffer — on either a monthly or annual plan — the cash flow immediately comes through the door. Even at a discounted price, securing an annual commitment from a customer is key.
According to Hubbard, getting annual cash upfront is a win for 2 main reasons:
- It makes it easier to create a budget and strategy for the year.
- The customer is typically more loyal and committed to the platform, not busy looking for alternatives.
Closely Monitor Tool Usage & Actively Negotiate Vendor Terms
As a fully remote firm, Buffer spends a lot of money on software tools. With the company’s tool budget nearing 7 figures, Caryn is extremely vigilant about this cash outlay.
To keep a lid on such expenses, Caryn works closely with the CTO and head of marketing (among others) to understand the firm’s tooling needs. A major issue that Hubbard tries to prevent is the duplication of resources. She doesn’t want Buffer paying for multiple tools that largely do the same thing.
For any major tool expenses (~$30-40k per year), Hubbard will negotiate with the providers and look to secure discounts on quarterly payments (if the annual option is not great). The pitch is simple: Buffer is business that you want to have.
For earlier-stage software firms that want to secure favorable terms from tool vendors, Hubbard says proving growth is key. If a supplier believes there is potential for future revenue and business, they may be willing to offer decent terms.