Chapter 4: Financial Reports – Statement of Financial Position and Statement of Cash Flows
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\(\newcommand{\avec}{\mathbf a}\) \(\newcommand{\bvec}{\mathbf b}\) \(\newcommand{\cvec}{\mathbf c}\) \(\newcommand{\dvec}{\mathbf d}\) \(\newcommand{\dtil}{\widetilde{\mathbf d}}\) \(\newcommand{\evec}{\mathbf e}\) \(\newcommand{\fvec}{\mathbf f}\) \(\newcommand{\nvec}{\mathbf n}\) \(\newcommand{\pvec}{\mathbf p}\) \(\newcommand{\qvec}{\mathbf q}\) \(\newcommand{\svec}{\mathbf s}\) \(\newcommand{\tvec}{\mathbf t}\) \(\newcommand{\uvec}{\mathbf u}\) \(\newcommand{\vvec}{\mathbf v}\) \(\newcommand{\wvec}{\mathbf w}\) \(\newcommand{\xvec}{\mathbf x}\) \(\newcommand{\yvec}{\mathbf y}\) \(\newcommand{\zvec}{\mathbf z}\) \(\newcommand{\rvec}{\mathbf r}\) \(\newcommand{\mvec}{\mathbf m}\) \(\newcommand{\zerovec}{\mathbf 0}\) \(\newcommand{\onevec}{\mathbf 1}\) \(\newcommand{\real}{\mathbb R}\) \(\newcommand{\twovec}[2]{\left[\begin{array}{r}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\ctwovec}[2]{\left[\begin{array}{c}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\threevec}[3]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\cthreevec}[3]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\fourvec}[4]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\cfourvec}[4]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\fivevec}[5]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\cfivevec}[5]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\mattwo}[4]{\left[\begin{array}{rr}#1 \amp #2 \\ #3 \amp #4 \\ \end{array}\right]}\) \(\newcommand{\laspan}[1]{\text{Span}\{#1\}}\) \(\newcommand{\bcal}{\cal B}\) \(\newcommand{\ccal}{\cal C}\) \(\newcommand{\scal}{\cal S}\) \(\newcommand{\wcal}{\cal W}\) \(\newcommand{\ecal}{\cal E}\) \(\newcommand{\coords}[2]{\left\{#1\right\}_{#2}}\) \(\newcommand{\gray}[1]{\color{gray}{#1}}\) \(\newcommand{\lgray}[1]{\color{lightgray}{#1}}\) \(\newcommand{\rank}{\operatorname{rank}}\) \(\newcommand{\row}{\text{Row}}\) \(\newcommand{\col}{\text{Col}}\) \(\renewcommand{\row}{\text{Row}}\) \(\newcommand{\nul}{\text{Nul}}\) \(\newcommand{\var}{\text{Var}}\) \(\newcommand{\corr}{\text{corr}}\) \(\newcommand{\len}[1]{\left|#1\right|}\) \(\newcommand{\bbar}{\overline{\bvec}}\) \(\newcommand{\bhat}{\widehat{\bvec}}\) \(\newcommand{\bperp}{\bvec^\perp}\) \(\newcommand{\xhat}{\widehat{\xvec}}\) \(\newcommand{\vhat}{\widehat{\vvec}}\) \(\newcommand{\uhat}{\widehat{\uvec}}\) \(\newcommand{\what}{\widehat{\wvec}}\) \(\newcommand{\Sighat}{\widehat{\Sigma}}\) \(\newcommand{\lt}{<}\) \(\newcommand{\gt}{>}\) \(\newcommand{\amp}{&}\) \(\definecolor{fillinmathshade}{gray}{0.9}\)Amazon's Cash Flow Position
In 2014, Amazon reported its quarterly earnings for their year-to-date earnings release. Since the trend has been for their profits to slide downward in the recent past, initial speculation was that this was causing investor discontent resulting in decreasing stock prices. But was it?
Even though profits were on a downward trend, the earnings releases showed that the operating section of the statement of cash flow (SCF) was reporting some healthy net cash balances that were much higher than net income. This is often caused by net income including large amounts of non-cash depreciation expense.
Moreover, when looking at free cash flow, it could be seen that Amazon had been making huge amounts of investment purchases, causing a sharp drop in the free cash flow levels compared to the operating section of the SCF. However, even with these gigantic investment purchases, free cash flow continued to soar well above its net income counterpart by more than $1 billion. What this tells investors is that there are timing differences between what is reported as net income on an accrual basis and reported as cash flows on strictly a cash basis.
The key to such cash flows success lies in the cash conversion cycle (CCC). This is a metric that measures how many days it takes for a company to pay it suppliers for its resale inventory purchases compared to how many days it takes to convert this inventory back into cash when it is sold and the customer pays their account. For example, if it takes 45 days to pay the supplier for resale inventory and only 40 days to sell and receive the cash from the customer, this creates a negative CCC of 5 days of access to additional cash flows. In industry, Costco and Walmart have been doing well at maintaining single-digit CCC's but Amazon tops the chart at an impressive negative 30.6 days in 2013. Apple also managed to achieve a negative CCC in 2013, making these two companies cash-generating giants in an often-risky high-tech world.
Amazon is using this internal access to additional cash to achieve significant levels of growth; from originally an online merchant of books to a wide variety of products and services, and, most recently, to video streaming. Simply put, Amazon can expand without borrowing from the bank, or from issuing more stock. This has landed Amazon's founder and CEO, Jeff Bezoz, an enviable spot in Harvard Business Review's list of best performing CEOs in the world.
So, which part of the CCC metric is Amazon leveraging the most? While it could be good inventory management, it is not. It is the length of time Amazon takes to pay its suppliers. In 2013, the company took a massive 95.8 days to pay its suppliers, a fact that suppliers may not be willing to accept forever.
Though it might have been too early to tell, some of the more recent earnings release figures for Amazon are starting to show the possibility that the CCC metric may be starting to increase. This shift might be a cause for concern for the investors. Moreover, this could be the real reason why Amazon's stock price was faltering in 2014 rather than because of the decreasing profits initially considered by many to be the culprit.
(Source: Fox, 2014)
After completing this chapter, should be able to:
- Describe the statement of financial position/balance sheet (SFP/BS) and the statement of cash flows (SCF), and explain their role in accounting and business.
- Explain the purpose of the SFP/BS.
- Identify the various disclosure requirements for the SFP/BS and prepare a SFP/BS in good form.
- Identify and describe the factors can affect the SFP/BS, such as changes in accounting estimates, changes in accounting policies, errors and omissions, contingencies and guarantees, and subsequent events.
- Explain the purpose of the statement of cash flows (SCF) and prepare a SCF in good form.
- Explain and describe an acceptable format for the SCF.
- Describe and prepare a SCF in good form with accounts analysis as required, and interpret the results.
- Identify and describe the types of analysis techniques that can be used for the SFP/BS and the SCF.
Introduction
In Chapter 3 we discussed three of the core financial statements. This chapter will now discuss the remaining two, which are the SFP/BS, and the SCF. Both of these statements are critical tools used to assess a company's financial position and its current cash resources, as explained in the opening story about Amazon. Cash is one of the most critical assets to success as will be discussed in a subsequent chapter on cash and receivables. How an investor knows when to invest in a company and how a creditor knows when to extend credit to a company is the topic of this chapter.
NOTE: IFRS refers to the balance sheet as the statement of financial position (SFP) and ASPE continues to use the term balance sheet (BS). To simplify the terminology, this chapter will refer to this statement as the SFP/BS, unless specific reference to either one is necessary.
Chapter Organization
