Revenue is Vanity, Profit is Sanity, But Cash is King!
Cash rules everything around me…CREAM…get the money…dollar dollar bill y’all…
If that introduction confused you, please open up Spotify, Apple Music, or Pandora (if you’re still in the internet ice age), and listen to the 1994 classic Hip Hop record C.R.E.A.M. by the Wu-Tang Clan!
Now that you got a small nostalgic taste of my childhood, let’s jump 10 years ahead where I’m in the first few years of my getting my accounting degree at Kent State University. At that time, my world revolved around banking, debits, credits, and company financials, and I was dreaming of a life that I would be Joshua Schall, MBA, JD, LLM…and having some insane corporate (tax) law practice. I obviously detoured just a tad into management consulting these last 11 years, but I never completely lost my accounting/finance lens…which you probably can easily notice from the approach I take in my content creation.
Overlooked Financial Metric?
In the below video from July 2020, I mentioned Gymshark’s canny ability to optimize cash conversion cycle to fuel its hyper-growth without outside investment. I got tons of messages that were interested in learning more about this often overlooked financial metric…that’s arguably one of the most important for CPG brands.
CCC Basics
Cash conversion cycle is a measure of how many days it takes for a business to turn invested cash (usually purchased inventory) back into cash in its bank account.
Why is this so important? C.R.E.A.M. (or in this case the CPG industry)
If you are a growing business, cash is king. A better cash position gives you an incredible amount of optionality. Anyone running a CPG business knows what rapid growth can do to your cash balance. As you pay down suppliers and order more inventory, in a blink of an eye, your cash can drain to zero.
That’s where optimizing your cash conversion cycle can help…
CCC Calculation
Let’s go over the cash conversion cycle…and I understand this calculation might look like a foreign language, but is very intuitive when you get a base understanding of it.
Days Inventory Outstanding (DIO) and Days Sales Outstanding (DSO) are associated with the company’s cash inflows, while Days Payable Outstanding (DPO) is linked to cash outflow.
To calculate CCC, you need several items from the financial statements:
Revenue and cost of goods sold (COGS) from the income statement
Inventory at the beginning and end of the time period
Account receivable (AR) at the beginning and end of the time period
Accounts payable (AP) at the beginning and end of the time period
The number of days in the period (e.g. year = 365 days, quarter = 90)
Stage 1 = focuses on the existing inventory level and represents how long it will take for the business to sell its inventory.
A lower value of Days of inventory outstanding is preferred, as it indicates that the company is making sales rapidly, and implying better turnover for the business.
Stage 2 = focuses on the current sales and represents how long it takes to collect the cash generated from the sales.
A lower value is preferred for Days of sales outstanding, which indicates that the company is able to collect capital in a short time, in turn enhancing its cash position.
Stage 3 = focuses on the current outstanding payable for the business. It takes into account the amount of money the company owes its current suppliers for the inventory and goods it purchased, and represents the time span in which the company must pay off those obligations.
A higher Days of payables outstanding value is preferred. By maximizing this number, the company holds onto cash longer, increasing its investment potential.
Case Study: $BRBR vs. $SMPL
To make this more real, let’s put CCC to the test with two of the largest functional CPG brands portfolios in the U.S. market. I’ll be utilizing the 23Q1 earnings period for:
Simply Good Foods (owner of Quest Nutrition)
BellRing Brands (owner of Premier Protein)
Simply Good Foods had a CCC value of 74.93
BellRing Brands had a CCC value of 85.98
Are these numbers good/bad/ugly? It varies substantial from category to category of the CPG industry, but I’ve seen historical averages of around 65.
As mentioned earlier, Gymshark actually had a negative CCC and Amazon bounces around 0 (or even negative) but these aren’t “normal.” Most businesses do NOT have a negative CCC…especially in the CPG industry. That means there is always on average 65 days of operating cash “stuck” in working capital. And as your business grows, the cash that is “stuck” will grow as well, meaning you’ll need to continually invest new cash into the business unless you focus on getting it “unstuck”.
So, when you see Simply Good Foods having a CCC value that’s ~11 days smaller, it doesn’t mean it’s a better company than BellRing Brands. It simply means that based on their recent CCC calculation, Simply Good Foods would (ceteris paribus) need less cash injected into their business to grow/scale larger. That being said, there are a number of reasons why BellRing Brands has a higher CCC value…and more importantly there are a number of levers you can pull to improve CCC in your CPG brand.
Increase AP
Your suppliers typically have default payment terms (e.g. net 30), but everything is negotiable, especially when you have some leverage (e.g. high-growth, large % of their business, or own the formulas). Moreover, make sure you’re keeping this conversation fluid overtime as internal/external dynamics adjust.
Bellring Brands = 35.2 days
Simply Good Foods = 27.8 days
The product portfolio of BellRing Brands is dominated by protein RTD contract manufacturing that’s also highly concentrated on a few supply partners. Due to leverage for that concentration, it has provided them a better payment term structure.
Reduce AR
This can wildly swing based on a CPG brand’s sales channel strategy, but I picked these two portfolios because they both have broad sales channel mix.
Bellring Brands = 44.1 days
Simply Good Foods = 43.6 days
Suggestions to improve DSO:
Increase your direct to consumer sales
Similar to supplier net terms, your retail partners have standard terms, but anything if up for negotiation as you have leverage
Bonus: If you’re an ecommerce heavy CPG brand, there are other ways to reduce DSO:
Consider a preorder strategy
Consider a platform strategy with services (or paid membership/subscriptions)
Reduce Inventory
Poor inventory management is the biggest bankrupter of CPG businesses! Improvement areas include:
dial in your demand forecasting
reduction of demand variability
reduce order sizes (and increase frequency)
reduce supplier lead times
reduce SKU variations (SKU rationalization)
How good (or poor) did our case study functional CPG perform:
Simply Good Foods = 59.2 days
Bellring Brands = 77.1 days
This is the main reason that Bellring Brands had a worse quarterly CCC. The reason likely surrounds the brand portfolio coming out of a low-stock period and they are working to rebuild brand and retailer inventories.
Bonus CCC Strategy
Use credit cards that extend your payback period. While having an American Express is great for accumulating points…it's a charge card and your payment is due on the same day each month. Instead, I’ve transitioned many of my clients to using a card like Parker. This card has a 60-day payback period that typically gives you massively larger credit limits with no interest or hidden fees.
Final Thoughts
Many people focus on a CPG brand’s amazing marketing campaigns, innovative products, or great leadership. I love that stuff too, but without the fundamentals of a company being incredible at financial management, there is no storybook ending. Simply put, if you’re running a CPG brand, you should be measuring and optimizing your cash conversion cycle regularly.