Cash Conversion Cycle – Big Companies Squeezing the Little Companies

Cash Conversion Cycle – Big Companies Squeezing the Little Companies

One of the more interesting business phenomena of the past decade has been the flow of cash in and out of large corporations. A metric called the cash conversion cycle looks at the amount of time needed to sell inventory, the amount of time needed to collect receivables and the length of time the company is afforded to pay its bills without incurring penalties.

At department store chain Macy’s, it’s 71 days; at the legendarily efficient Wal-Mart, 12 days; at Costco, with its limited inventory and super-fast turnover, it’s just four days; at Amazon, the cash conversion cycle was negative 24 days in 2014. That is, on average the company took in cash from customers 24 days before it paid it out to suppliers.

How does Amazon make this happen? Here’s the explanation that the company gives every quarter in its earnings reports:
“Because of our model we are able to turn our inventory quickly and have a cash-generating operating cycle. On average, our high inventory velocity means we generally collect from consumers before our payments to suppliers come due.”

The reality is Amazon’s inventory turns is the same as Wal-Mart’s at 45 days, and is higher than Costco’s 30 days. What explains why its cash cycle is negative compared to Wal-Mart and Costco is how long it takes Amazon to pay people. Amazon’s average Days Payable Outstanding is about 90 days, meaning it takes an Amazon supplier 90 days on average to get paid for a sale they made to Amazon. Costco and Amazon are between 30 and 40 days.
Amazon is clearly making a choice to boost its own cash flow by making life harder for its suppliers. Unfortunately for the small business, other large corporations are taking notice and working hard at reducing their own Cash Conversion Cycles. Delaying payments to suppliers is becoming fashionable according to Stephanie Strom as reported in the New York Times in April 2014.
In the past, extended payment terms often were a signal that a company was experiencing worrisome cash flow problems, but these days big, robust companies are imposing new schedules on suppliers as a business strategy, analysts say.

The suppliers who have to deal with these extended payment terms tend to be smaller and have fewer resources than the companies delaying payment.
“Eventually,” said V. G. Narayanan, chief of the accounting practice unit at Harvard Business School, “the additional financing costs that suppliers incur because they aren’t being paid promptly work their way back into higher prices for consumers.” The practice is often crippling for suppliers, especially smaller businesses that have little cushion. Banks have tightened up lending, especially to small businesses, so it becomes even harder to manage. You still have a payroll to make, your own suppliers to pay, electric and other utility bills — they can’t wait four months for payment.

“I think the whole idea is very bad,” Professor Narayanan of Harvard said. “They essentially are going to their suppliers for credit, rather than their banks — and for big, creditworthy companies like these, that’s ridiculous.”