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What Is The Cash Machine Business Model 2022? – How Does It Work?
Therefore, the metric follows how many days it takes for a company to sell its products or services, get paid for them, and pay its suppliers.
Companies using a cash machine business model usually have a short cash conversion cycle. These companies either offer cash sales or have significantly low credit terms, allowing them to receive cash from customers promptly.
Similarly, some of these companies use their cash resources to pay suppliers readily to avoid lengthening their cash conversion cycle.
Similarly, companies using a cash machine business model have low-profit margins to generate high volume sales. However, for some of them, the necessity to keep low margins may come due to the disruptive industry in which they operate. The cash machine business model is most suitable for companies that keep inventory.
How Does The Cash Machine Business Model Work?
The cash machine business model is straightforward. A company buys its raw materials from a supplier. It may either pay the supplier at the time of the transaction with cash or use its credit facilities.
Then the company works towards processing its raw materials and converting them into finished goods. After that, the company waits for customer orders.
Once the company receives an order, it ships the goods to its customers. Usually, cash machine companies don’t offer credit transactions and receive their cash promptly.
It allows them to substantially reduce their cash conversion cycle by not having to wait until customers pay. However, some companies may also offer credit terms to customers to attract more sales.
However, the credit terms that companies offer for their sales in this model are usually short-term. For example, these companies may offer a 5-10 days credit term.
Likewise, it is one of the reasons why a company can keep its cash conversion cycle low. Lastly, when the customer repays the company for the goods purchased, the company reimburses its suppliers.
The primary factors that influence the success of a company that uses this mode are receiving cash from customers promptly and repaying suppliers.
It allows companies to collect a cash surplus, which further helps them repay suppliers before obtaining further payments from customers, which shortens their cash conversion cycle even more.
What Are The Advantages And Disadvantages Of The Cash Machine Business Model?
The cash machine business model has several advantages and disadvantages. Some of these consist of the following.
Advantages
Using a cash machine business model allows companies to smooth out their operations and processes. By receiving cash from customers promptly and repaying suppliers, companies can avoid any latency in their cash flows. It further allows them to predict or forecast their cash flows for budgeting and control purposes.
The business model also allows companies to minimize their credit risk. Credit risk is the risk associated with the repayment of loans by borrowers.
If a borrower fails to repay a company, it results in bad debts. Therefore, companies using this model usually face the lowest and, sometimes, no bad debts, at all.
A cash machine business model also allows companies to make use of any incentives offered by suppliers. If a company keeps a low cash conversion cycle, it means it repays its suppliers on time.
Therefore, if a supplier provides a cash discount for early repayments, companies can exploit their business model to reimburse them less.
Companies using this model can also generate excess cash flows and avoid cash shortages. By exploiting those situations, companies can reinvest their cash in new projects and earn more from them. Therefore, the cash machine business model allows them to generate higher cash inflows and expand their businesses.
Disadvantages
While the cash machine business model is about shortening a company’s cash conversion cycle, it may not always be a good thing. For example, by repaying suppliers promptly, companies don’t benefit from waiting out through the credit term period and utilizing the cash elsewhere.
Similarly, by not offering customers shorter credit terms or none at all, companies may lose customers. As mentioned, companies can avoid credit risk with it. However, taking the risk can result in higher rewards and more sales as well.
Examples
Some well-known companies that utilize the cash machine business model are Amazon and Apple. They offer no credit terms to customers, which allows them to collect any cash promptly from customers.
Similarly, they use the money to repay their suppliers on time, allowing them to have a significantly lower cash conversion cycle.
Conclusion
The cash machine business model is for companies that believe in a short cash conversion cycle. The business model works by decreasing or eliminating the time it takes companies to collect receipts from customers. Similarly, it allows them to repay their suppliers on time.
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What Is Cash Conversion Cycle? Amazon Cash Machine Business Strategy In A Nutshell
How does the cash conversion cycle work?
There are three aspects to take into account the cash conversion cycle:
- Days inventory outstanding
- Days sales outstanding
- Days payable outstanding
In other words, how long it takes for an item from when it sits in your inventory to when it is sold. How long it takes for you to cash the sale. And how much time you have to pay back suppliers.
Case study
Imagine you buy from an online store (just like Amazon). You ordered an item and spent $50. You’ll get the item in 7 days. The online store has already collected the $50 and will ask the supplier to send it over to you within a week. But the store will pay the supplier only after 30 days. This means that now the store has $50 that can spend the next three weeks before the amount is due to the supplier. Those three extra weeks are crucial as the money could be spent to order other items and sell them with the same cash conversion cycle.
Therefore when an organization learns how to use its cash conversion cycle appropriately, its financial model drives its business strategy to fuel the growth of the business.
I want to show you how Amazon uses a negative cash conversion cycle to generate extra liquidity to power up its business growth.
A better look at Amazon’s profitability
If you look at Amazon’s income statement, you’ll see that its operating income when it comes to the e-commerce side it’s tight.
The part of the business that has high margins is related to Amazon AWS:
Instead, Amazon’s e-commerce platform, while it does have much better margins compared to the past, is still low compared to other parts of the business.
Yet, the company generates substantial cash from the operations.
Amazon’s continuous blitzscaling
So how does Amazon generate so much cash from operating activities?
The answer is in the cash conversion cycle, or the ability of Amazon to keep its operating margins low and yet generate short-term liquidity to keep expanding the business.
In fact, on the one side, Amazon has to make sure to keep its prices low, as this is part of its mission, and on the other side through the cash conversion cycle, the company can still generate cash, unlocked to grow the operations.
This is a sort of business strategy driven by a financial model that drives the whole business. Thus, Amazon can keep its aggressive pricing strategy and yet still manage to continuously expand its operations.
The Amazon business model, combined with its financial model made it take over several industries along the way. And it enabled Amazon to be in a continuous “blitzscaler-mode” nonetheless its size.
Understanding Amazon’s financial model
A financial model, driven by cash conversion cycles, can be used for generating additional cash by efficiently managing three aspects:
- Days inventory outstanding (how long it takes before we sell that item we have sitting in the store?)
- Days sales outstanding (how long it takes to get paid by our customers?)
- Days payable outstanding (how much time we have before we are due to our suppliers?)
Amazon is quite successful in managing its cash conversion cycle.
In fact, as of 2017, gurufocus.com reported that Amazon had a cash conversion cycle of -26.92!
- Amazon.com Inc’s for the three months ended in Dec. 2017 was 19.87.
- Amazon.com Inc’s for the three months ended in Dec. 2017 was 35.27.
- Amazon.com Inc’s for the three months ended in Dec. 2017 was 82.06.
Therefore, Amazon.com Inc’s Cash Conversion Cycle (CCC) for the three months ended in Dec. 2017 was -26.92.
It practically means that Amazon has almost thirty days before payments are due to its suppliers, while it has already generated available cash for the business by selling items in its online store!
But how and when does it make sense to operate a cash-generating business model? I believe there are four main aspects to take into account:
- Trust from customers
- Digitalization
- Negotiating strength
- Inventory
First, you need to be Trusted by customers
Before Amazon could become so efficient in managing its cash conversion cycle business strategy, it took years to become trusted by its customers. Today Amazon.com is one of the most popular websites on earth, where each day billions of people purchased anything:
Digitalization makes it easier
With digitalization, it has become easier for online stores to manage their cash conversion cycle. For instance, think of the case in which you open up a store with a simple landing page. You don’t have anything down yet, but you start getting sales in.
Once an item gets pre-ordered, you can get it from a supplier and send it over to a final customer. In short, digitalization helps companies keep a more efficient inventory based on what customers order online even before they have it sitting in the inventories.
That is not an Amazon case. Amazon played the opposite business strategy: build giants super-organized inventories called Fulfillment Centers.
Fulfillment centers are the key to Amazon successful cash conversion cycle strategy
Amazon has been investing billions of dollars in automating and making more efficient its “fulfillment centers.” That, of course, helped the company to strengthen its cash conversion cycle:
Advantageous credits terms with suppliers
Another aspect is the company’s ability to negotiate convenient payment terms with its suppliers. If you’re able to stretch the payment agreement terms in a way that allows you to run your business on credit, it becomes easier to have excess cash to invest in the business operations growth. Just like Amazon has been doing in the last years.
Affiliate networks and programs
Another critical element of Amazon’s successful cash business strategy was built upon a network of publishers around the web, that in exchange for a referral to Amazon products could get a fee. This is the premise of affiliate marketing, on which Amazon has also built its fortune.
Key takeaways
- The cash conversion cycle is a crucial aspect of any business in which success is based on short-term liquidity. When current assets minus current liabilities is positive, it means the company can generate extra cash from its operations.
- If well managed the cash conversion cycle can become a sort of cash-making machine that generates additional liquidity for an organization.
- This is a sort of financial model that combined with a viable business model can unlock substantial growth for the business!
Below a summary of how it all works:
Breaking down Amazon’s Flywheel
