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Jade Harrison12/11/2015ACCT 1120Mrs. HatfieldAmazon Financial Analysis ReportINTRODUCTIONBefore one invests in a company, it is crucial that they analyze the financial statements to determine whether or not they are making a smart investment. A company’s financial statements are a report on a company’s health and their many abilities that help maintain financial security. This paper reports on the analysis for Amazon’s annual reports for the years 2011 and 2012. Five very important sections are evaluated through the use of ratios that determine how risky of an investment Amazon would be for an individual. The five sections include, the ability to pay current liabilities, the ability to sell merchandise inventory and collect receivables, the ability to pay long-term debt, evaluating profitability, and evaluating stock as an investment. Through this report, one will be able to see how worthwhile it is to invest in Amazon. ABILITY TO PAY CURRENT LIABILITESThe first assessment one would make regarding payment of current liabilities, is the calculation of the current ratio. To calculate a company’s current ratio, you take the total current assets and divide by the total current liabilities. A current ratio is defined as, “a company’s ability to pay its current liabilities with its current assets” (Nobles, Mattison, and Matsumura, pg. 1023). For Amazon, their total current assets for 2012 came to $21,296 while their total current liabilities add up to $19,002. When the assets are divided by the liabilities, Amazon’s current ratio equals 1.12. The ratio is a step down from the previous ratio of 1.17 that is calculated for 2011. With the industry average being 1.54, both 2011 and 2012 are very weak years for Amazon. Since these ratios are below average, it would appear as though Amazon does not have sufficient current assets to maintain normal business operations. Another calculation to determine a company’s ability to pay current liabilities is found through the acid-test ratio. This test assesses the company’s ability to pay all of its current liabilities if they were to come due immediately. Compared to the current ratio, the acid test ratio is described as being much more stringent. To compute the acid-test ratio calculation, take the cash and cash equivalents and then add short term investments along with the net current receivables. Then divide the total of these figures by the total current liabilities. Since merchandise inventory and prepaid expenses are the least liquid of current assets, they are not used in this ratio calculation. Amazon finds their acid-test ratio to be at 0.78 for 2012 and 0.82 for 2011. The industry average comes to 1.82, so Amazon is lagging behind quite a bit. Amazon can definitely look towards making improvements to catch up to the industry average. But overall, Amazon is not as capable of paying its current liabilities as it needs to be in order to stay competitive with other industries. ABILITY TO SELL MERCHANDISE INVENTORY AND COLLECT RECEIVABLESWhen measuring a company’s ability to sell merchandise inventory and collect receivables, we begin with the calculation of inventory turnover. The definition of inventory turnover is, “the number of times a company sells its average level of merchandise inventory during a year” (pg. 1025). If a company has a high turnover rate, selling inventory is much easier, whereas, a low rate is much more difficult. To compute inventory turnover, take the cost of goods sold and the average merchandise inventory rather than the sales. This is due to sales not being comparable to merchandise inventory because it is retail instead of cost. With the cost of goods sold as the numerator, divide the denominator of average merchandise inventory to figure the inventory turnover. The industry average for Amazon’s inventory turnover comes to 4.8 while Amazon’s turnover in 2012 comes to 8.3 and in 2011 comes to 9.1 Being above the industry average is a strength that Amazon can find advantageous. The next step in determining the ability to sell inventory and collect receivables is determining the day’s sales in receivables ratio. The day’s sales in receivables ratio, “indicates how many days it takes to collect the average level of receivables” (pg. 1028). In order to reckon the calculation, divide 365 days by the accounts receivable turnover ratio. According to the text in Horngren’s Accounting, “the number of days in average accounts receivable should be close to the number of days customers are allowed to make payment. The shorter the collection period, the more quickly the organization can use its cash. The longer the collection period, the less cash is available for operations” (pg. 1028). Amazon has a ratio of 17.7 for 2012 and 15.8 in 2011. Compared to the industry average of 36.11, Amazon has a ratio that is considered stronger for their industry.Another step in these calculations is the gross profit margin. This ratio, “measures the profitability of each net sales dollar above the cost of goods sold” (pg. 1026). Before beginning to calculate this ratio, gross profit needs to be figured. Gross profit is net sales minus the cost of goods sold. Once the gross profit is computed, divide it by net sales revenue to reckon the gross profit margin. With the gross profit margin, one can determine a business’s ability to earn a profit on the merchandise inventory. This measure of profitability is one of the most carefully watched, according to Horngren’s Accounting, (pg. 1026). The text further states that, “the gross profit earned on merchandise inventory must be high enough to cover the remaining operating expenses and to earn net income. A small increase in the gross profit percentage from last year to this year may signal an important rise in income” (pg. 1027). Amazon finds itself below the industry average of 33.55% with a gross profit margin of 24% at 2012 and 22% at 2011. Amazon needs to make improvements in this area, and in order to do so, they need to decrease the cost of merchandise inventory and/or increase revenue. ABILITY TO PAY LONG-TERM DEBTWith the debt ratio, a business can evaluate their ability to pay debts. The debt ratio, “shows the proportion of assets financed with debt”, (pg. 1028), through the relationship between total liabilities and total assets. If a company has a higher debt ratio, the company has a higher financial risk. Amazon has a debt ratio of 75% for 2012 and 69% for 2011, whereas the industry average is lower with a debt ratio of 34%. Amazon is at a higher financial risk due to their debt ratio being more than 30% above average. Their debt ratio increased more than 5% from 2011 to 2012, which is a red flag for the company. With the times-interest-earned ratio, you can evaluate a business’s ability to pay interest expense. If a business is looking for a calculation that measures, “the number of times earnings before interest and taxes can cover interest expense” (pg. 1029), they turn to this ratio. If the times-interest-earned ratio is high, a business can easily pay interest expense, whereas a low ratio means they have difficulty. To calculate this ratio, add together net income, income tax expense, and the interest expense, and then divide it all by the interest expense. For Amazon, their 2011 ratio was well over the industry average of 5.33. The 2011 times-interest-earned ratio came to 15.18, which is very strong. The next year, 2012, there was a great decrease in this ratio all the way to 5.23. This puts Amazon in a riskier place for paying interest expense with it being .10 less than the industry average. EVALUATING PROFITABILITY The number one goal a company strives to accomplish, is the ability to earn a profit. There are a few important calculations to determine how profitable a company truly is. To calculate a company’s percentage of each net sales dollar earned as net income, you would use the profit margin ratio. This is computed by dividing net income by net sales. With this ratio, the focus is on the profitability of a business and shows how much net income a business earns on every $1.00 of sales. It appears as though Amazon has struggled to earn a decent profit through the years 2011 and 2012. Their profit margin ratio for 2011 was 1.31% and for 2012 their profit margin ratio found itself in the negatives at -0.06%. The industry average is up to 2.87% which means Amazon is not earning enough of a profit compared to others in its industry. With a higher profit margin, more sales dollars end up as profit. 2012 was a very weak year for Amazon in regards to profit. Another calculation that determines profitability, is the rate of return on common stockholders’ equity. This ratio, “shows the relationship between net income available to common stockholders and their average common equity invested in the company. The rate of return on stockholders’ equity shows how much income is earned for each $1 invested by the common shareholders” (pg. 1031). To figure this calculation, take the net income and subtract from it any preferred dividends. Then divide by the average common stockholders’ equity. Amazon’s return on equity is at a -0.49% for 2012 and at an 8.63% for 2011. These numbers are both below the industry average of 11.39%. A company has higher leverage if their debt ratio is high. Leverage can increase profitability during positive periods, but leverage isn’t always positive. Leverage can compound losses during bad times. Amazon is far from being able to leverage with a ratio of -0.49% for 2012. With Amazon being below the industry average, they are not doing very well and should re-evaluate this area. EVALUATING STOCK AS AN INVESTMENT The ratios computed in evaluating stock are very helpful to analysts. Investors want to earn a return on their investment when they go to purchase stock. To begin, the price/earnings ratio is important to understand, “the market price of a share of common stock to the company’s earnings per share. The price/earnings ratio shows the market price of $1 of earnings” (pg. 1033). For the price/earnings ratio calculation, take the market price per share of common stock and divide by the earnings per share. Amazon has a very negative price/earnings ratio for 2012 at -2,854.7, while the 2011 price/earnings ratio is 131.37. The 2011 ratio was much stronger than the 2012 ratio due to it being well above the industry average of 47.17. Amazon’s 2011 ratio means that their stock was selling at 131.37 times one year’s earning. With the astounding decrease for the 2012 ratio, net income is less controllable. CONCLUSIONAlthough Amazon is a very convenient website with a wide array of inventory, taking a further look at the financial statements highlights what this company truly has to offer. Amazon does not have strong capabilities of paying off its debt, as evidenced through the current ratio and the acid-test ratio. Their acid-test ratio is lagging very much behind, which could spell terrible trouble for Amazon if they do not take the correct measures to reverse this. While the company does struggle to pay off its current liabilities, they appear to be doing much better in selling merchandise inventory and collecting receivables. Their inventory turnover is above industry average which is very good, and their days’ sales in receivables ratio proves to be strong as well. Unfortunately, Amazon’s gross profit margin is below the industry average and needs to be improved. When it comes to paying long-term debts, Amazon finds itself a red flag with a 5% increase in their debt ratio. Just as well, their ability to pay interest expense is also in a very risky place. As for profitability, Amazon is much less profitable than many might think it would be. Their profit margin ratio was down in the negatives for the year 2012 while the rate of return on common stockholders’ equity was also in a negative area. Both of these numbers are a decrease from the previous year’s profitability. Amazon’s stock was a strong investment for 2011 with the number being well above the industry average, but 2012 showed an alarming drop into the negatives. Overall, Amazon needs to make some sort of improvement in all five areas to remain competitive and relevant to their competition for the future, as well as safer for investors. ................
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