Chapter 4: Financial Reports – Statement of Financial Position and Statement of Cash Flows

In 2014, Amazon reported its quarterly earnings for their year-to-date earnings release. Since the trend has been for their profits to slide downward in the recent past, initial speculation was that this was causing investor discontent resulting in decreasing stock prices. But was it?

Even though profits were on a downward trend, the earnings releases showed that the operating section of the statement of cash flow (SCF) was reporting some healthy net cash balances that were much higher than net income. This is often caused by net income including large amounts of non-cash depreciation expense.

Moreover, when looking at free cash flow, it could be seen that Amazon had been making huge amounts of investment purchases, causing a sharp drop in the free cash flow levels compared to the operating section of the SCF. However, even with these gigantic investment purchases, free cash flow continued to soar well above its net income counterpart by more than $1 billion. What this tells investors is that there are timing differences between what is reported as net income on an accrual basis and reported as cash flows on strictly a cash basis.

The key to such cash flows success lies in the cash conversion cycle (CCC). This is a metric that measures how many days it takes for a company to pay it suppliers for its resale inventory purchases compared to how many days it takes to convert this inventory back into cash when it is sold and the customer pays their account. For example, if it takes 45 days to pay the supplier for resale inventory and only 40 days to sell and receive the cash from the customer, this creates a negative CCC of 5 days of access to additional cash flows. In industry, Costco and Walmart have been doing well at maintaining single-digit CCC’s but Amazon tops the chart at an impressive negative 30.6 days in 2013. Apple also managed to achieve a negative CCC in 2013, making these two companies cash-generating giants in an often-risky high-tech world.

Amazon is using this internal access to additional cash to achieve significant levels of growth; from originally an online merchant of books to a wide variety of products and services, and, most recently, to video streaming. Simply put, Amazon can expand without borrowing from the bank, or from issuing more stock. This has landed Amazon’s founder and CEO, Jeff Bezoz, an enviable spot in Harvard Business Review’s list of best performing CEOs in the world.

So, which part of the CCC metric is Amazon leveraging the most? While it could be good inventory management, it is not. It is the length of time Amazon takes to pay its suppliers. In 2013, the company took a massive 95.8 days to pay its suppliers, a fact that suppliers may not be willing to accept forever.

Though it might have been too early to tell, some of the more recent earnings release figures for Amazon are starting to show the possibility that the CCC metric may be starting to increase. This shift might be a cause for concern for the investors. Moreover, this could be the real reason why Amazon’s stock price was faltering in 2014 rather than because of the decreasing profits initially considered by many to be the culprit.

(Source: Fox, 2014)