Natalie's Portfolio



memorandumDate:15 Nov 2013To:Lynnette YerburyFrom:Natalie Stroud ParisiSubject:Financial Analysis of IntroductionThis paper is designed to analyze the financial information on the public corporation in 2008, which is an online retailer that provides merchandise sales. In this document I will discuss my opinion of the company’s financial position, and specifically look at their liquidity, profitability and solvency. I will address each of these separately and analyze the financial information accordingly.When evaluating a company’s financial position, there are certain tools of analysis available to help understand what the financial statements represent.In this document we will use the Ratio Analysis tool to analyze the three main topics listed above. This tool includes different ratio formulas expressed in terms of a percentage, a rate, or a proportion.All information has been pulled from Amazon’s 2007 and 2008 Fiscal Year Annual Reports, accessible through their website (). These reports follow the Form 10K of the United States Securities and Exchange Commission and are in accordance with generally accepted accounting principles (AAR, pg. 77). They have been audited by Ernst and Young LLP, an Independent Registered Public Accounting Firm, to “determine whether effective internal control over financial reporting was maintained” by (AAR, pg. 78). Basically, what this tells us is that the information is accurate and reliable, and that it has been reported and presented properly to Amazon’s Shareholders’ and to the general public.About The , Inc. was incorporated in 1994 in the state of Washington and reincorporated in 1996 in the state of Delaware. Their corporate offices are located in Seattle, Washington. They opened their virtual doors on the Internet in July of 1995 and have International and North American operations. They serve their consumer customers through retail websites and also offer programs that enable seller customers to sell their products on the Amazon websites and to fulfill orders through Amazon (AAR, pg. 3).Liquidity (Amazon’s ability to pay current liabilities)The first analysis will be in regards to Amazon’s liquidity. Liquidity is the ability to pay off short-term creditors within a one-year period or within the current operating cycle (annually), whichever is longer (TB, pg., 174).Financial statement reviewers look closely at the relationship between a company’s assets (cash valued items) and liabilities (debts), and more specifically at current items, which means that they can be converted or paid off within the year or current operating cycle. If current assets are more than current liabilities then the company is okay to meet necessary obligations, but if it’s the other way around then they may be in trouble (TB, pg. 175).Current assets most often include cash, accounts receivable, inventory, prepaid expenses, equipment and buildings. Current liabilities are generally accounts payable, notes payable, salaries and wages payable, taxes payable and current maturities of long-term debt.To help in identifying Amazon’s liquidity the Ratio Analysis formulas used include the:Current RatioAcid-Test RatioReceivables Turnover/Average Collection PeriodInventory Turnover/Days in Inventory (TB, pg. 843)Analysis of Amazon’s LiquidityThe following is my analysis of Amazon’s liquidity, using the formulas listed above. Each will include a comparison of the current-year (2008) to the prior-year (2007), and also to the industry averages (2008).Current RatioTo get the ratio you divide current assets by current liabilities. This measures Amazon’s short-term debt-paying ability.For 2008, Amazon had a ratio of 1:1.30 and for 2007, they had a ratio of 1:1.39. The online retail sales industry average was 1:1.37.The 2008 ratio tells us that for every dollar of current liabilities, Amazon has $1.30 of current assets. For 2007, it’s $1 to $1.39, and for the industry its $1 to $1.37. Their current ratio has declined in the current year and is below the industry average, but not by a significant amount. They have liquidity but not by a favorable amount. Their liquidity is declining and if it continues to decline then they are going to have a problem.Acid-Test RatioTo get this ratio you add cash, short-term investments, and net-receivables, then divide that total by current liabilities. This measures Amazon’s immediate short-term debt paying ability from only its highly liquid assets (cash, short-term investments, and net receivables).For 2008, Amazon had a ratio of 1:0.96 and for 2007, they had a ratio of 1:1.03. The industry average was 1:1.00.The ratio tells us that for 2008, Amazon’s highly liquid assets are not adequate to cover their current liabilities and are below the industry average. Their 2007 ratio indicates that they were barely covering the current liabilities for that year. Based on this data they have a problem if they need to pay off debts immediately and if they continue trending in this direction. They also fall below the industry average, which is matching dollar for dollar.Receivables Turnover Ratio/Average Collection Period RatioThe receivables turnover ratio is calculated by dividing net credit sales (net sales minus cash sales) by average net accounts receivables. This, along with the average collection period ratio, measures Amazon’s liquidity based on how quickly they can convert receivables to cash, in order to pay off debt.For 2008, Amazon’s ratio was 25.02 times and for 2007 it was 26.9 times. The industry average was 29.6 times.The ratio tells us that in 2008, the number of times, on average, that Amazon collected receivables during the year was 25.02. In 2007, they collected receivables more often. Compared to the industry average, Amazon is slower in their ability to convert their receivables.The average collection period ratio is calculated by dividing the receivables turnover ratio into 365 days. This gives us the average collection period of receivables in terms of days. Generally the collection period should not greatly exceed the time allowed for payment.For 2008, the average collection period for Amazon was 15 days and for 2007 it was 14 days. The industry average was 12 days, so Amazon is not far behind in terms of days.Inventory Turnover Ratio/ Days in Inventory RatioThe inventory turnover ratio is calculated by dividing cost of goods sold by average inventory. This, along with the days in inventory ratio, measures Amazon’s liquidity based on how quickly they can convert inventory to cash, in order to pay off debt.For 2008, Amazon had a ratio of 11.5 times. For 2007, the ratio was 11.1 times. The industry average was 10.8 times.This ratio tells us the number of times, on average, that Amazon’s inventory was sold during the year. Their inventory turnover increased slightly in 2008, meaning that they are improving their ability to pay debts based on inventory. They are turning over inventory faster than the industry average, which indicates that they are doing well with sales.The days in inventory ratio is calculated by dividing the inventory turnover ratio into 365. This gives us the average collection period of inventory in terms of days.For 2008, the average collection period for Amazon was 32 days and for 2007 it was 33 days. The industry average was 34 days. Amazon has improved their turnover from 2007 and is turning over inventory 2 days faster than the industry average.Liquidity ConclusionThis data indicates that inventory is Amazon’s best practice for liquidity in the short-run. However, if something doesn’t change in the long-run then they are going to have issues in their ability to pay off their obligations, as indicated by the trends in the current ratio and acid-test ratio.Their position within the industry is relatively stable, but could be headed in the wrong direction.Profitability (Amazon’s ability to generate money)My second analysis is in regards to Amazon’s profitability. Profitability is a company’s earning power and their ability to generate money. It indicates operational success and effectiveness for a business. It also measures income (losses and gains), which affects the company’s ability to obtain debt and equity financing, as well as their liquidity position and ability to grow (TB, pg. 838).To help in identifying Amazon’s profitability the Ratio Analysis formulas used include the:Profit MarginAsset TurnoverReturn on AssetsReturn on Common Shareholders’ EquityEarnings Per SharePrice-Earnings RatioPayout Ratio (TB, pg. 843-44)Analysis of Amazon’s ProfitabilityProfit MarginTo get this ratio you divide net income by net sales. This is a percentage measure of each dollar of Amazon’s sales that results in a gain or a loss (net income).For 2008, Amazon had a profit margin of 3.4% and for 2007, it was 3.2%. The industry average was 2.7%.The ratio tells us that Amazon has a healthy profit margin and it is continuing to increase. It also tells us that they are above the industry average. Amazon is a high-volume business, which means that its profit margin percentage is generally low.Asset Turnover RatioThe asset turnover ratio is calculated by dividing net sales by average assets. This measures Amazon’s use of its assets to generate sales.For 2008, Amazon’s ratio was 2.3 times and for 2007 it was 2.7 times. The industry average was 2.3 times.The ratio tells us that in 2008, Amazon generated sales of $2.30 for each dollar it had invested in assets. In 2007, $2.74 was produced for each dollar invested in assets. Currently Amazon is matching the industry average, but the trend shows that they are declining. $0.44 is a somewhat significant decline in generated sales.Return on AssetsTo measure Amazon’s return on assets, you divide net income by average assets. This measures their overall profitability. For 2008, Amazon’s return was 8.7% and for 2007 it was 8.8%. The industry average was 6.2%.Amazon’s return on assets declined from 2007 to 2008, but very insignificantly. Compared to the industry average, Amazon has a higher return on assets so they are still profitable in this regard.Return on Common Stockholders’ EquityThe return on common stockholders’ equity can be calculated in two ways, depending on if the company has preferred stock dividends or not. Amazon did issue dividend for preferred stock, so the calculation used to determine their return was net income divided by average stockholders’ equity. This measures Amazon’s profitability for the common stockholders’ point of view.For 2008, Amazon’s return was 33.3% and for 2007 it was 58.5%. The industry average was 16.1%.This rate tells us that in 2008, $214,785,000 of the $645,000,000 total net income was earned form investments by stockholders. In 2007, the rate was much higher, earning $278,460,000 of the $476,000,000 total net income. Compared to the industry average, Amazon is earning more of its net income from stockholders investments. This indicates that they rely on investors for a large portion of their profitability.Earnings Per Share (EPS)/Price-Earnings Ratio (P-E)Earnings per share is calculated by dividing net income by the weighted-average of common shares outstanding (not dollars per share). Again, if preferred stock dividends had been issued then we would deduct that amount. This measures Amazon’s net income earned on each share of common stock. It is meaningful only when used for trend analysis of the specific company being analyzed.For 2008, Amazon earned net income of $1.53 on each share of common stock. For 2007, they earned $1.15 per share. The industry average was $1.58 per share but this information isn’t meaningful because of the wide variation in the outstanding shares of stock of other companies.This tells us that Amazon’s earnings increased $0.38 per share which is a decent increase.The price earnings ratio is calculated by dividing the market price per share of stock by the earnings per share calculated above. This measures the market price of each share of common stock to the earnings per share.For 2008, the ratio was 101 times and for 2007 it was 123 times. The industry average was 78 times.This tells us that in 2008, each share of Amazon’s stock sold for 101 times the amount that they earned on each share. In 2007 it sold for an even higher amount then what they earned. Their price-earnings ratio is much higher than the industry average, indicating that stock sells are great for generating profitability.Payout RatioThis would be used to calculate the percentage of earnings distributed in the form of cash dividends, but Amazon has never declared or paid cash dividends. Considering Amazon generates a large amount of their profitability from stock, the fact that they have not paid dividends is concerning. If I were a shareholder of Amazon stock I would be concerned with this information.Profitability ConclusionThis data indicates that Amazon’s profitability relies heavily on common stock to generate profits. In their annual report, they state clearly that their focus for profitability is in the long-run. That seems to be an unusual approach to operations of a successful corporation. For now, they are still in the game but their profitability model will need to change.Again, their position within the industry is relatively stable, but they are on a very slippery slope. If investors stop purchasing stock, the majority of their profit generating operations will cease to be and they will not survive.Solvency (Amazon’s ability to pay long-term debt)My last analysis is regarding solvency. Solvency is a company’s ability to meet maturing obligations as they come due. It measures the ability of a company to survive over a long period of time (TB, pg. 842).To help in identifying Amazon’s solvency the Ratio Analysis formulas used include the:Debt to Total Assets RatioTimes Interest Earned Ratio (TB, pg. 844)Analysis of Amazon’s SolvencyDebt to Total Assets RatioThe debt to total assets ratio is calculated by dividing total debt by total assets. This measures Amazon’s percentage of the total assets that creditors provide. It also indicates Amazon’s degree of leverage, and their ability to withstand losses without damaging creditor’s interests.For 2008, Amazon’s ratio was 67.9% and for 2007 it was 81.5%. The industry average was 55%.The ratio tells us that in 2008 Amazon’s ability to meet its maturing obligations is high. In 2007, the risk was even greater. If the Amazon trend continues to decline then they are moving in the right direction, but for now they are highly at risk. Compared to the industry average, Amazon is also at a higher risk.Times Interest Earned RatioTimes interest earned is calculated by dividing income before income taxes and interest expense by interest expense. This provides an indication of Amazon’s ability to meet interest payments at their due date. For 2008, Amazon’s ratio was 11.9 times and for 2007 it was 8.5 times. The industry average was 27.55 times.The ratio tells us that Amazon is increasing its ability to meet interest expense internally but, compared to the industry average Amazon is poorly covered.Solvency ConclusionThis data indicates that internally amazon is a solvent company.Their position within the industry indicates that they are at high risk for failure to meet long-term obligations.Analysis ConclusionI believe that Amazon is in need of some major changes in order to continue operations and survive as a corporation. They are currently okay with meeting their short-term obligations but, the trend shows that those numbers are declining. They are profitable at present due to stockholder success, but if that changes then they won’t be generating enough to survive. Their long-run position within the industry does not look good or indicate a successful future.Taking into consideration all three of these factors, they are headed into a bad financial situation and need to do something about it while they still can.Sources Cited:AAR indicates Amazon’s Annual Report pulled from their website. The link to this report is: TB indicates the Principles of Financial Accounting class textbook. ................
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