Question

1. Review the chapter's opening story involving Amazon.com and its founder, Jeff Bezos.

Keeping Amazon above Water SEATTLE-Market gurus warn us of companies with losses and rising debt. One of those companies, however, is Amazon.com (Amazon.com 2), the largest U.S. Internet retailer. Jeff Bezos, founder and CEO of Amazon, started the company in his garage. "The first initial start-up capital for Amazon.com came primarily from my parents, and they invested a large fraction of their life savings," recalls Jeff. “My dad's first question was, 'What's the Internet?.. He wasn't making a bet on this company or this concept. He was making a bet on his son." Jeff has grown Amazon from an online bookstore into one of the world's largest online retail stores to compete with the likes of Walmart and Target. Interestingly, although Amazon reports negative income and rising debt, the market sees the company in a positive light. Forbes named Amazon the sixth "Most Innovative Company in the World" and ranked it as the thirteenth "World's Most Valuable Brand.” Given Amazon's losses and debt levels, is the market failing to fully reflect the accounting information? Is there something else that the market is focusing on? Let's dig a bit deeper. Amazon's financial statements reveal rising sales, nearly doubling over the past four years Although costs exceeded sales in two of the recent four years, the growth in revenues foretells a positive future Amazon's cash flows are equally revealing. The key here is its operating cash flows, which have increased 185% over the past four years an impressive result! In addition, its large investing cash outflows are what we expect from a growth company. Its relatively small financing cash inflows reveal that much of its expansion is self-funded-a good situation. Analysis of Amazon requires examination of its cash flows. While only the future can reveal if the positive cash flow trend will lead to positive income, it is clear the market uses cash flow numbers in predicting Amazon's future. "We earn trust with customers over time," insists Jeff. "And that actually does maximize free cash flow over the long term

Required:  

a. In a business such as Amazon.com, monitoring cash flow is always a priority. Even though Amazon now has billions in annual sales and sometimes earn a positive net income, explain how cash flow can lag behind net income.

b. Amazon is a publicly-traded corporation. What are potential sources of financing for its future expansion?

c. Explain how even in periods of net loss for Amazon, it still manages to show positive cash flow. (Hint: Think about sources of cash.)

2. Katie Murphy is preparing to meet with her banker. Her business if finishing its fourth year of operations. In the first year, it had negative cash flows from operations. In the second and third years, cash flows from operations were positive. However, inventory costs rose significantly in year 4 and cash flows from operations will probably be down by 25%. Murphy wants to secure a line of credit as a financing buffer. From experience, she knows the bank will scrutinize operating cash flows from year 1 to 4 and will want a projection for year 5. Murphy wants to show a steady rise in operating cash flows. She decides to use here discretion as owner and considers several business actions that will turn her operating cash flows from a decrease to an increase.

a. Identify two business actions Murphy might take to improve cash flows from operations.

b. Comment on the ethics and possible consequences of Murphy's decision to pursue these actions.

Answer 1

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