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N290 Business and Finance : Analyzing the Fundamentals of a Business

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In reference to the readings on the topic of Cash Flows in this unit, read the articles via the links below and provide a critique about Amazon focus on Cash Flow rather than profits. Critically evaluate how analysts and investors view profits as a performance measure in their analysis of financial data and argue whether Amazon approach can be sustainable into the future. Good question and well linked to the LOs

Answer:

Introduction:

For amazon, financial analysis is primarily important as it will assess the actual situation of the company and its performance. However, Amazon is using cash flow analysis statement more than its profitability index. This is sustainable since a company’s cash flow financial statement is a reflection of the company’s profitability levels and the financial health of the company. As a leading company in the world, Amazon is highly profitable and has a positive cash flow over the last couple of years. This shows it also has a profitable structure that runs into billions. Financial analysis is based on financial indicators calculations to express the profitability, yield, indebtedness, operational efficiency and liquidity(Allman, 2013).

When analyzing the fundamentals of a business, most of the time attention is usually focused on the company's accounting earnings. But free cash flow can be a more valuable and transparent indicator in this regard. In addition, statistical data demonstrate that selecting investments based on cash flows tends to produce long-term winning results.

Cash Flow vs. Earnings

Accounting gains and cash flow are two related but materially different concepts. The accounting result of a company measures the sales and costs in a certain period, beyond if the income and expenses of cash were realized or not in that particular period. Instead, cash flows show cash inflow and outflow through different paths(Subramanyam, Wild and Halsey, 2014).

There is no magic or infallible formula for selecting winning actions. However, investing in companies with high returns for free cash flows makes enough theoretical sense, and empirical evidence shows that the practical results tend to be attractive.The accounting results of the business are based on all types of assumptions and assumptions of the firm's management team; this includes estimates of depreciation and amortization, inventory accounting, or bad loans, among other things. On the other hand, cash flow does not address these issues, it simply reflects inflows and outflows of funds, therefore, it is an indicator that cannot be manipulated by the management of the company to the same extent as accounting results(Subramanyam, Wild and Halsey, 2014).

In this case for Amazon, it may happen that the business faces liquidity needs, before which it needs to issue debt or new shares to raise capital. Instead, when we select assets based on their cash flow, we will be focusing on companies that do not need external financing to continue growing, which has clear benefits in terms of risk and sustainability.

A classic indicator in this regard is free cash flow, which is calculated by taking operating cash flows and discounting investments in capital expenditure. Basically, free cash flow tells us how much cash the business produces from its operations after financing the investments needed to sustain and continue to grow(Li, 2013).

Conclusion:

As with other similar indicators, it is very important to keep in mind that business cash flows can change over time, and the analysis should always be dynamic as opposed to static. The key is to pay attention to the evolution of cash flows over time, and not assume that a certain value for a particular year tells us everything we need to know about the business. Beyond this, statistical data indicate that selecting companies based on profitability by free cash flow tends to be a winning strategy over time. According to a study by Manning Napper Advisors, shares of companies with a high free cash flow return tend to outperform the market average. In the same sense, the data are consistent in this regard, indicating that there is a direct relationship between profitability through free cash flow and investor earnings: (Lutolf-Carroll, LLP and Pirnes, 2014).

References:

Allman, K. (2013). Modeling structured finance cash flows with microsoftexcel. Hoboken, N.J.: Wiley.

Li, J. (2013). Risk management of supply and cash flows in supply chains. [Place of publication not identified]: Springer.

Lutolf-Carroll, C., LLP, W. and Pirnes, A. (2014). From innovation to cash flows. Hoboken, N.J.: Wiley.

Subramanyam, K., Wild, J. and Halsey, R. (2014). Financial statement analysis. New York, NY: McGraw-Hill Education.

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