Question

Watching Amazon Flows

Seattle- Market gurus warn us of companies with losses and rising debt. one of those companies, however, is Amazon.com the largest U.S. Internet retailer. Jeff Bezos, founder and CEO of Amazon, started the company in his garage. "The first initial start-up capital for Amazon.com came primarily from my parents, and they invested a large fraction of their life savings," recalls Jeff. "My dad's first question was, 'What's the Internet?'... He wasn't making a bet on this company or this concept. He was making a bet on his son."
Jeff has grown Amazon from an online bookstore into one of the world's largest online retail stores to compete with the likes of Walmart and Target. Amazon's income and liabilities for the past four years follow:

($ millions) 2011 2012 2013 2014
Net Income $631 $(39) $274 $(241)
Liabilities 17,521 24,363 30,413 43,764

Interestingly, while Amazon reports negative income and rising debt, the market sees the company in a positive light. Financial publications such as Forbes named Amazon the 6th "Most Innovative Company in the World" and ranked it as the 13th "World's Most Valuable Brand."
Given Amazon's losses and debt levels, is the market failing to incorporate this? Is there something else that the market is focusing on?
Lets dig a bit deeper. Amazon's financial statement reveal rising sales, narly doubling over the past four years. Although costs exceed slaes in two of the recent four years, the growth in revenues foretells a positive future. Further, Amazon has pursued sizeable investments in research and development --to the tune of $9 billion in 2014 alone, which could yield large future payoffs. Finally, there are its cash flows, which are depicted here:

($ millions) 2011 2012 2013 2014
Operating CF $3903 $4180 $5475 $6842
Investing CF (1930) (3595) (4276) (5065)
Financing CF (482) 2259 (539) 4432

Akey here is its operating cash flows, which have increased 75% over the past four years... an impressive trend! In addition, its large investing cash outflows are what we expect from a growth company. Also, its relatively small financing cash inflows suggest that much of its expansion is self-funded (a positive finding).
It is clear that analysis of Amazon requires examination and interpretation of its cash flows. Moreover, while there is risk in investing in a company with high research and development outlays, the market often sees such outlays as a precursor to sales and income growth. While only the future can reveal the success or failure of such cash outlays, it is clear that the market utilizes cash flow numbers in predicting the future and for stock valuation. "We earn trust with customers over time," insists Jeff. "And that actually does mazimize free cash flow over the long term."

Review the chapter's opener involving Amazon.com and its founder, Jeff Bezos. (UP ABOVE)

Requred

1. In a business such as Amazon, monitoring cash flow is always a priority. Even though Amazon now has billions in annual sales and sometimes earns a positive net income, explain how cash flow can lag behind net income.

2. Amazon is a publicly traded corporation. What are potential sources of financing for its future expansion?

Answer 1

1. You prepare a cash flow statement with the help of the income statement and the balance sheet. You prepare it by adding net income from income statement, adding back non cash expenses and adding back non cash items in the balance sheet.

In the income statement, revenue-expenses=income. But it doesn’t tell you the real cash balance or the increase or decrease in cash for the period. Due to accrual accounting, income is not always cash.

For example, if the business is paid and it receives a cheque and it is postdated, it cannot cash it for a couple of weeks. Then it did not get that cash yet. So, the income statement is not correct in this case. It is revenue but its not cash revenue.

Therefore, cash flow statement can include some items, which were recorded as income in the previous period but were not recorded as cash during the period. This is how cash flow lags behind income.

2. Potential sources of financing for expansion:

1. Issue of new shares

2. Issuing preference shares

3. Rights issue, which is a means for existing shareholders to subscribe to new shares in proportion to their current shareholding

4. Retained earnings

5. Bank loans. It could be short term, mid term or long-term bank loans.

6. Debentures, which is an unsecured debt instrument.

I hope that was helpful :)