Question

Please describe the financial concepts below linking with what you know about Amazon.com

1) Free Cash Flow

2) Value Creation

3) Operating Cycle (Cash Conversion Cycle)

4) Working capital management

5) Capital Budgeting

Answer 1

1) Free Cash Flow

Free cash flow (FCF) represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. Unlike earnings or net income, free cash flow is a measure of profitability that excludes the non-cash expenses of the income statement and includes spending on equipment and assets as well as changes in working capital from the balance sheet.

Interest payments are excluded from the generally accepted definition of free cash flow. Investment bankers and analysts who need to evaluate a company’s expected performance with different capital structures will use variations of free cash flow like free cash flow for the firm and free cash flow to equity, which are adjusted for interest payments and borrowings.

Similar to sales and earnings, free cash flow is often evaluated on a per share basis to evaluate the effect of dilution.

2) Value Creation

Value creation is the primary aim of any business entity. Creating value for customers helps sell products and services, while creating value for shareholders, in the form of increases in stock price, insures the future availability of investment capital to fund operations. From a financial perspective, value is said to be created when a business earns revenue (or a return on capital) that exceeds expenses (or the cost of capital). But some analysts insist on a broader definition of "value creation" that can be considered separate from traditional financial measures. "Traditional methods of assessing organizational performance are no longer adequate in today's economy," according to ValueBasedManagement.net. "Stock price is less and less determined by earnings or asset base. Value creation in today's companies is increasingly represented in the intangible drivers like innovation, people, ideas, and brand."

3) Operating Cycle (Cash Conversion Cycle)

An Operating Cycle (OC) refers to the days required for a business to receive inventory, sell the inventory, and collect cash from the sale of the inventory. This cycle plays a major role in determining the efficiency of a business.

The OC formula is as follows:

Operating Cycle = Inventory Period + Accounts Receivable Period

Where:

• Inventory Period is the amount of time inventory sits in storage until sold.
• Accounts Receivable Period is the time it takes to collect cash from the sale of the inventory.

4) Working capital management

Working capital management is a business strategy designed to ensure that a company operates efficiently by monitoring and using its current assets and liabilities to the best effect. The primary purpose of working capital management is to enable the company to maintain sufficient cash flow to meet its short-term operating costs and short-term debt obligations.A company's working capital is made up of its current assets minus its current liabilities.

5) Capital Budgeting

Capital budgeting is the process a business undertakes to evaluate potential major projects or investments. Construction of a new plant or a big investment in an outside venture are examples of projects that would require capital budgeting before they are approved or rejected.

As part of capital budgeting, a company might assess a prospective project's lifetime cash inflows and outflows to determine whether the potential returns that would be generated meet a sufficient target benchmark. The capital budgeting process is also known as investment appraisal.