Assessment Description

Answer the questions below with reference to the following sources and submit:

1) A word document with answers to the below questions on Turnitin 

2) An excel document with supporting calculations in the drop box on the portal (in Assessment table)

Source 1: Amazon Annual Report

Amazon 2018 Annual Report: https://ir.aboutamazon.com/static-files/0f9e36b1-7e1e-4b52-be17-145dc9d8b5ec

Source 2: Working Capital Management Amazon

At Amazon, It’s All About Cash Flow

Justin Fox October 20, 2014

The far more interesting things in Amazon’s earnings releases, it turns out, can be found on the cash flow statement. Here, for example, are the company’s net income and cash flow over the past decade:

The difference between the top and bottom lines here is mostly about investments in buildings, machines, and other things, which are written down over time in the income statement but ignored in calculating operating cash flow. That operating cash flow is much higher than net income at a company that has been investing huge amounts of money as it strives for global retail domination isn’t a big surprise, although the sheer size of the difference, and the sharp upward trajectory of the cash flow line, is still staggering.

 Free cash flow does count all of Amazon’s investments — although it counts them when the money is spent instead of depreciating and amortizing them over subsequent years. That it has remained consistently higher (usually more than $1 billion higher) than net income is a remarkable and very important thing.

 With free cash flow, on the other hand, what counts is when the money actually changes hands. So if you have a business where your customers pay you quickly, you manage your inventory well, and you’re able to take your time in paying your suppliers, your free cash flow can be consistently positive even when your net income is not. Which is exactly the kind of business that Jeff Bezos and his colleagues have constructed at Amazon over the past decade. 

According to my instructor in such matters, Harvard Business School finance professor Mihir Desai, the key metric of a company’s cash-generating prowess is the cash conversion cycle, which is days of inventory plus days sales outstanding (how long it takes your customers to pay you, basically), minus how many days it takes you to pay your suppliers. Super-efficient retailers such as Walmart and Costco have been able to bring their CCC down to the single digits. That’s impressive. But at Amazon last year, the CCC was negative 30.6 days.

In Amazon’s case, all this cash is being used to finance the company’s continued explosive growth. The company doesn’t need to borrow, it doesn’t need to issue stock. It can just keep spending its own cash to attack new sectors and upgrade its offerings. … all that cash flowing in and sticking around a while before it has to go back out again makes it possible for the company to undertake experiments, learn from mistakes, and keep plowing ahead regardless of what those on the outside (such as shareholders) think. So an apparent failure like the Amazon Fire phone can be treated as a learning experience rather than a crisis.

 Still, it’s crucial to this approach that Amazon’s fine-tuned cash machine keeps humming. In its 10Qs, Amazon invariably attributes its “cash-generating operating cycle” to good inventory management: “On average, our high inventory velocity means we generally collect from consumers before our payments to suppliers come due,” is the boilerplate explanation

Actually, though, it isn’t inventory management that distinguishes Amazon from Walmart and Costco. Walmart has an “inventory velocity” similar to Amazon’s while Costco, with its limited selection, turns its inventory substantially faster. Walmart and Costco also both get paid by customers more quickly than Amazon does. Where Amazon stands out is how excruciatingly long it takes it to pay its suppliers — 95.8 days on average last year, according to Morningstar, compared with 30.1 for Costco and 38.5 for Walmart. 

Skeptics have argued in the past that suppliers may not be willing to put up with that forever. And in fact, recent quarterly reports seem to show the payables period shrinking and Amazon’s cash conversion advantage narrowing (the company’s business is extremely seasonal, so quarterly numbers are pretty noisy). It’s too early to tell whether this is the new normal, but it is an entirely reasonable thing for investors to worry about. Which is probably a much better explanation for why Amazon’s stock price has been sputtering this year than the story that shareholders are “losing patience.” Source: https://hbr.org/2014/10/at-amazon-its-all-about-cash-flow

Part A: Company Financing 

1. According to Source 2 how did Amazon’s Cash Conversion Cycle in 2013 compare to other retailers in that year? What does it say about Amazon’s working capital management? 

2. According to Source 2 why is having a negative Cash Conversion Cycle important for a company wanting to experiment with investing in new products that could fail or succeed?

3. If Amazon couldn’t use cash to fund its new projects, what two financing options would they have available to them (see Source 2)? Discuss what advantages and disadvantages these financing options would have for Amazon. 

4. Based on Source 1 (Annual Report) what is Amazon’s Cash Conversion Cycle in 2018? How does this compare with the Cash Conversion Cycle in 2013 (Source 2) and what does it say about Amazon’s supplier relationships? 

5. Based on Pages 6-14 of Amazon’s Annual Report (Source 1) what do you believe are the three most significant risks facing Amazon in 2018? Are these risks systematic or unsystematic? Why? 

6. Imagine that in 2007 you purchased an Amazon $1000 face value bond with a fixed annual coupon rate of 4.5% which matures at the end of 2020. Currently it is the end of 2019 and the bond has a yield to maturity of 5%. What would be the price of the bond today in 2019? 

7. Consider Source 3. If you bought Amazon shares at the beginning of June 2014 and sold them at the beginning of June 2019, what would be your approximate holding period return? (Assume no dividends.) What does this suggest about the investments that Amazon made from 2014 to 2019?