Evaluating the Ability To Pay Current Liabilities

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1 Kelsey McCarty Amazon Financial Analysis Paper The purpose of this paper will to break down a company s financial statements using various ratios to determine if Amazon is a profitable and efficient company. The results from the ratios that are used will be compared to industry averages to show that profitability and efficiency. The ratios and equations that will be covered and explained, show Amazon s ability to pay off current liabilities, long term debt, and will evaluate their ability to sell merchandise and collect accounts receivable, their profitability, and their stock as an investment. It is important to remember that all of the numbers used in the ratios and equations are in the form of millions (Ex: 39= $39,000,000). Industry averages will be provided below the tables with the said equations. Evaluating the Ability To Pay Current Liabilities Working Capital= Current Assets Current Liabilities 2012 $21,296 $19,002 = $2, $17, 490 $14,896 =$6,345 Working capital is the first thing that is looked at when determining a company s ability to pay current liabilities. This shows that Amazon has more assets than liabilities and is good to know, but isn t sufficient enough to give all of the desired details. The rest of the equations will provide more helpful, detailed information. Current Ratio

2 Current Ratio= Total Current Assets/Total Current Liabilities 2012 $21,296/$19,002 = $17,490/$$14,896 =1.17 Industry Average: 1.54 The current ratio shows the company s ability to pay current liabilities from current assets. Amazon s current ratio increased by a little bit which is great for company. Since the industry average is 1.54, that is an area that Amazon could improve. The indication is that the company is too liquid and isn t using its assets effectively. The company could improve their ratio by reducing their inventory so other resources aren t tied up (Miller Nobles, Mattison, Matsumura, 2016, p.888). Cash Ratio Cash Ratio= Cash+Cash Equivalents/ Total Current Liabilities 2012 $8,084/$19,002 = $5,269/$14,896 = 0.35 The cash ratio helps to determine a company s ability to meet its short term obligations. Having below a 1.0 cash ratio is desirable. Having a high ratio could imply that the company has too much cash on hand and having too low of a ratio could mean the company doesn t have enough money to pay short term debts (Miller Nobles, Mattison, Matsumura, 2016, p.888). Amazon s cash ratio in 2012 increased by.08 which is a good thing. Since having too high and too low of a ratio can be detrimental, the safe zone is around 0.50.

3 Acid Test Ratio Acid Test Ratio = Cash and Cash Equivalents+ Short Term Investments+ Net current receivables/total Current Liabilities 2012 $8,084+$3,364+$3,364/$19,002 = $5,269+$4,307+$2,571/$14,896 = 0.82 Industry Average: 0.82 The acid test ratio tells whether the company can pay all of its current liabilities if they all came at once immediately (Miller Nobles, Mattison, Matsumura, 2016, p.889). Amazon s acid test ratio decreased from 2011 to 2012 and is right below the industry average. Having an acid test ratio of is what most industries should aim for (Miller Nobles, Mattison, Matsumura, 2016, p.889). Decreasing the total liabilities or increasing the cash or other assets will increase their acid test ratio. All of the above listed ratios help determine what position a company is in as regarding to paying current liabilities. Having more assets than liabilities will always help. But, as long as the company is at or above the industry average and in the desired ranges by the Risk Management Association, then a company will be in a good position to pay off its current liabilities. Evaluating the Ability To Sell Merchandise and Collect Receivables In evaluating the ability to sell merchandise and collect receivables there are quite a few ratios used. How many times a year a company sells its merchandise, how many days the merchandise is in stock, and measuring the profitability of each sales dollar above the cost of goods sold will be explained.

4 Inventory Turnover Ratio Inventory Turnover= Cost of goods sold/ Average merchandise inventory 2012 $45,971/5, = 8.3 times 2011 $37,288/4,097 = 9.1 times Industry average: 4.8 times Inventory turnover is the number of times a company sells its average level of merchandise in a period (Miller Nobles, Mattison, Matsumura, 2016, p.890). A low turnover rate means that the company is having difficulty selling inventory and a high rate means they re selling it quickly. The 2012 ratio decreased, but since the average inventory is higher it s as surprising. Since the industry average is 4.8 times, Amazon is doing really well. Days Sales Inventory Ratio Days sales inventory= 365 days/ inventory turnover days/ 8.3 = days days/ 9.1 = days Industry average: days Days sales inventory measures how many days that inventory is held in a company (Miller Nobles, Mattison, Matsumura, 2016, p.889). Companies should try to be around industry average. In 2012 the ratio increase which is a good thing. However, it is low compared to the industry average so Amazon can increase merchandise to lower the amount of days the merchandise is held. Gross Profit Percentage

5 Gross Profit Percentage= Gross Profit/ Net Sales Revenue 2012 $15,122/$61,093 = 24% 2011 $10,789/$48,077 = 22% Industry average: 33.55% The gross profit percentage of a company measures the profitability of each net sales dollar above the cost of goods sold. Amazon s 2012 percentage rose by 2%, which means there was an increase in income. Since the percentage is well below the industry average, they need to decrease the cost of inventory or increase revenues (Miller Nobles, Mattison, Matsumura, 2016, p.891). Accounts Receivable Turnover Ratio Accounts receivable turnover ratio= Net credit sales/ Average net accounts receivable 2012 $61,093/ = times 2011 $48,077/2019 = times Industry average: times The accounts receivable turnover ratio shows how many times the average receivables are collected in a year.the year 2012 decreased by about 3 times, which is good because too high of a number means that credit may be too tight (Miller Nobles, Mattison, Matsumura, 2016, p.891).since 2012 s ratio is double the industry average; it is good, Amazon just shouldn t let it get too high. Days Sales In Receivables Ratio

6 Days sales in receivables= 365 days/ accounts receivable turnover ratio days/20.59 = 17.7 days days/23.13 = 15.8 days Industry average: days Days in sales receivables ratio displays the number of days it takes to collect the average level of receivables.(miller Nobles, Mattison, Matsumura, 2016, p.891). Shorter collection periods mean the organization can use cash quicker In the year 2012 the number of days slightly increase, but is much lower than the industry average, a good indication. After comparing the current year to previous year as well as the industry average, Amazon is efficient at selling merchandise and collecting receivables. They should try to improve their gross profit percentage and days sales in inventory to increase income. Evaluating The Ability To Pay Long Term Debt Debt Ratio Debt ratio= Total Liabilities/ Total Assets 2012 $24,363/$32,555 = 75% 2011 $17,521/$25,278 = 69% Industry average: 34% The debt ratio shows the percentage of liabilities financed with debt. Anywhere from 57% 67% is ideal (Miller Nobles, Mattison, Matsumura, 2016, p.892). The ratio in 2012 spiked by 6% which is a concern. However, it is a high risk position since it is more than double

7 the industry average. Debt To Equity Ratio Debt to equity ratio= Total liabilities/total equity 2012 $23,363/$32,555 = 72% 2011 $17,521/$25,278 = 69% Industry average: 52% This shows whether a company is financing more assets with debt than equity or equity than debt. Less than 1 (100%) means that a company is financing more assets with equity (Miller Nobles, Mattison, Matsumura, 2016, p.893). The percent didn t increase a whole lot in 2012, but compared to the industry, Amazon is at high risk. Times Interest Earned Ratio Times interest earned ratio= Income before taxes+income Tax Exp.+Int. Exp./Int. Exp 2012 $544/$92 = 5.23 times 2011 $934/$65 = times Industry Average: 5.33 times This ratio shows a business ability to pay interest expense. A high ratio is desirable (Miller Nobles, Mattison, Matsumura, 2016, p.893). In 2012 the ratio dropped dramatically, and is even lower than the industry average. However, Amazon isn t having difficulty paying its liabilities. Amazon is efficient at paying off its liabilities. Their debt ratio is just a little higher than ideal. According to their debt to equity ratio they are financing more assets with equity than

8 debt. And, based on their times interest numbers, they pay off their liabilities quickly. Evaluating Profitability No matter what business you are, you want to make a profit. The next equations will measure Amazon s profitability. From these numbers we can also determine how they can become more profitable. Profit Margin Ratio Profit margin ratio= Net Income/Net sales 2012 $39/$61,093 = 0.06% 2011 $63/$48,077 = 1.31% Industry average: 2.87% The percentages show how much money a business earns on every $1.00 of sales. You want a high profit margin because more sales dollars are ending up as profit (Miller Nobles, Mattison, Matsumura, 2016, p.893). The margin in 2012 nosedived from 2011 and isn t anywhere close to the industry average. Rate of Return on Assets Rate of return on assets ratio= Net income+interest Exp./ Average total assets 2012 $131/$28,916.5 = 0.45% 2011 $631/$22,037.5 = 2.57% Industry Average:4.76% The above numbers measure a company s success in using assets to raise profit

9 (Miller Nobles, Mattison, Matsumura, 2016, p.893). Because the 2012 ratio is negative, it means there was a net loss that year. It decreased significantly since 2011 and is well below the industry Average. Asset Turnover Ratio Asset turnover ratio= Net sales/average total assets 2012 $61,093/$28, = 2.11 times 2011 $48,077/$22, = 2.18 times Industry average: 1.66 times This show how efficiently a business generates sales from their total assets. The amount of times decreased a little bit in between 2011 and But, 2012 s amount is still well above the industry average which indicates they re more efficient than the average. Rate of Return on Common Stockholder s Equity Return on Common Stockholder s Equity= Net Income Preferred Dividends/Avg. Stockholder s Equity 2012 $39 0/$7,974.5 = 0.49% 2011 $631 0/$73,105 = 8.63% Industry average: 11.39% This measures the amount of money available to stockholders as well as the average equity invested in the company. A good rate of return is 15% 20% (Miller Nobles, Mattison, Matsumura, 2016, p.893) In 2012 the rate dropped dramatically from 2011 and is below the industry average. Earnings Per Share Ratio

10 EPS Ratio= Net income Preferred Dividends/Average number of common outstanding stock 2012 $ 39/454.5 = $ 0.09 per share 2011 $631/ 453 = $1.39 per share Industry average: $10.54 Displays amount of money earned/loss for each share. It decreased by 106% since 2011 and is way below industry average. Amazon must increase its net income to increase the ratio. Amazon was not a very profitable company in Many of their ratios decreased when they should be trying to make them increase. They need to increase their income, sales, and decrease their amount of inventory to become more profitable. Evaluating Stock As An Investment Investors want to earn a return on their stock investments. These equations show their gain/loss from selling the stock and their paying out of dividends. The results will show if Amazon is wisely investing in stock. Price Earnings Ratio P/E Ratio= Market price of common stock/ EPS 2012 $256.92/ 0.09 = 2, $182.61/1.39 = Industry average: Shows how much stock is selling at times one year s earnings. In 2012 stock was selling at 2, times the year s earnings. It plummeted from It is well below the industry average so Amazon should try to keep it in line with the industry average.

11 Amazon didn t pay dividends in either year so the equations for Dividend Yield and Dividend Payouts aren t required. Dividend Yield is the percent that stockholders receive back from the company and can be found by dividing the annual dividend per share by the market price per share. If the percent is lower than the industry average then you aren t paying out as much money to stockholders. Dividend payouts measure the amount paid annually to common stockholders. The equation is annual dividend per share/eps. The ending percent is the amount that a stockholder can expect to receive based on the payout ratio. Based on Amazon s P/E ratio they ll want to increase their earnings per share to make money off their stock. To conclude on the overall financial health of the business, Amazon didn t have a great year in Many of their ratios dropped dramatically when they should ve stayed the same or increased. And, their net loss was $39 million dollars for the year. Luckily, they had a good enough year in 2011 that the company should be able to absorb the losses in However, in order to avoid another year like 2012, Amazon should seriously look at their financial statements and make ways to improve and become more efficient and more profitable. References Miller Nobles, Tracie. Mattison, Brenda. Matsumura, Ella Mae. (2016). Accounting: The Financial Chapters. (Eleventh Edition). Pearson.