The Cash Conversion Cycle
Large retailers like Walmart (WMT), Target (TGT), Costco (COST) and Internet retailer Amazon.com (AMZN) generate billions in revenue annually. Walmart's revenue is over $1.2 billion on a daily basis. No wonder there are so many Waltons on Bloomberg's Billionaire list. All of this revenue translates into a lot of clothes, toys, pet food, barbies, cleaning supplies and who knows what else but it is a lot of "stuff". Managing this inventory is a monumental logistical feat and doing it better than competitors translates into big gains for the company and its shareholders.
So how is an investor to track the efficiency of managing inventory, accounts receivable and accounts payable? Enter the Cash Conversion Cycle (CCC). The cash conversion cycle is the theoretical amount of time between a company spending cash and receiving cash per each sale, output, unit of operation, etc. It is basically a measure of how long cash is tied up in working capital. The CCC is a great way to analyze the efficiency of the organization in managing cash to generate more sales. See the chart below with the cash conversion cycle for Wal-Mart, Target, CostCo and Amazon.com.
Wal-Mart is the largest by far and still manages to convert cash through the cycle in under 10 days which is well below Target's 27 days but above CostCo's 4.5 days. Amazon.com is the outlier with a negative cash conversion cycle which is great for Amazon. Bezo's manages to hold inventory for 28.9 days plus 10.6 days to collect receivables or 40 days in total but then pays accounts payable in 54 days thus achieving a negative cash conversion cycle for Amazon.com of -14 days. You don't see this that often but definitely a win for Amazon shareholders. Maybe not for the suppliers waiting for their checks.
Does the cash conversion cycle matter? You be the judge. Look at the chart below.
The best stock returns over the past five years were generated by the firms that managed their cash conversion cycle the most efficiently. Amazon posted the biggest gains with a negative CCC, then CostCo, Wal-Mart and Target finished last. So the next time you decide to get exposure in the retail space be sure to check the CCC. If the cash conversion cycle is broken the retailer might be too.