Retailers like Amazon create cash by buying goods from vendors and selling them to consumers. In accounting there is a metric called Cash Conversion Cycle (CCC) which can be used to measure just how efficient a retailer is at buying inventory, selling it to customers and collecting payments, and paying its suppliers. Cash conversion cycle measures the lag between when companies have to pay their suppliers and when they get paid by their customers.
We recently made Amazon Cash Conversion Cycle public, and while it fluctuates a lot seasonally, it was -38 last year. What this number means is that after Amazon collected payments from customers it only paid their suppliers 38 days later.
Most importantly, negative cash conversion cycle means that Amazon is able to fund their growth using vendors as a credit line.
In a Bloomberg article “Big Companies Don’t Pay Their Bills on Time”, Justin Fox wrote:
“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.”
In comparison, Amazon has a negative number of days. This is a pretty rare occurrence. There are few companies to do it better than Amazon, Apple being one of them.
The cash conversion cycle consists of three parts: the amount of time needed to sell inventory (Days Inventory Outstanding), the amount of time needed to collect receivables (Days Sales Outstanding) and the length of time the company is afforded to pay its bills without incurring penalties (Days Payable Outstanding).
Days payable outstanding is worth highlighting because it is a metric smaller retailers can easily measure too. Days payable outstanding tells how long it takes a company to pay its invoices.
Last year it took Amazon on average 104 days to pay its invoices.
This is more than 90 day terms. When considering that it takes Amazon less than 45 days to turn inventory into sales it reveals how effective Amazon is at using inventory to fund their growth. And while their ability to turn inventory into sales has been decreasing over time, they have increased terms with vendors (sometimes forcing vendors to accept or not sell at all).
In terms of cashflow alone, Amazon growth is largely thanks to favorable terms with vendors and its ability to forecast demand. By not overspending on inventory it isn’t going to sell fast enough, Amazon is able to sell it before it has to pay its invoices.
It is interesting to note that marketplace sellers usually get paid every 2 weeks, a much shorter cycle than vendors. However Amazon is not carrying any risk with their inventory, since it’s up to sellers to manage it. Thus Amazon gets up to 2 weeks to use it for other investments.
Any extra day of the difference between when inventory sold and when it has to be paid for is an opportunity to invest into growth. As long as Amazon continues to grow, this access to cheap capital is going to remain key. Many retailers would agree that having a negative cash conversion cycle is the golden ticket of retail. We think many of the top amazon sellers are trying to follow a similar metric.