AMAZON.

COM REPORT

Very good report showing thorough understanding of the different theories. Exceptional level of
analysis and application to the company. All theoriers are correctly cited to their original authors. A
very good piece of work. Well done

80%

WORD COUNT: 2498

FINANCIAL DECISION MAKING
UMADFJ-15-M
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Table of Contents

Glossary...............................................................................................................................................2
Introduction..........................................................................................................................................3
1. Long-term Sources of Finances................................................................................................3
2. Working Capital Management...................................................................................................5
3. Dividend Policy............................................................................................................................6
4. Profitability & Risk.......................................................................................................................8
Summary..............................................................................................................................................9
Appendices........................................................................................................................................11
Appendix 1A – Amazon Statement of Cash Position at 31 December 2016....................................12
Appendix 1B – Amazon Statements of Comprehensive Income for the year ending 31 December
2016.................................................................................................................................................13
Appendix 1C – Amazon Consolidated Statements of Financial Position for the year ending 31
December 2016...............................................................................................................................14
Appendix 1D – eBay Statement of Cash Position at 31 December 2016........................................15
Appendix 1E – eBay Statements of Comprehensive Income for the year ending 31 December 2016
.........................................................................................................................................................16
Appendix 1F – eBay Consolidated Statements of Financial Position for the year ending 31
December 2016...............................................................................................................................17
Appendix 2A – Gearing Ratio Calculations......................................................................................18
Appendix 2B – Liquidity Ratio Calculations.....................................................................................19
Appendix 2C – Working Capital Ratio Calculations..........................................................................21
Appendix 2D – Profitability Ratio Calculations................................................................................25
Appendix 2E – Beta Capital Asset Pricing Model Calculations.........................................................29
References...........................................................................................................................................30

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Glossary

YOY Year over Year

CCC The Cash Conversion Cycle
WCC The Working Capital Cycle
M&M Modigliani and Miller

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Introduction
This report will critically review the underpinning theories of long-term sources of
finance, working capital management, dividend policies and the Minsky moment to
understand Amazon’s risk and return characteristics. It will explore Amazon's
business model, market structure and link its profitability to the risk of the company.
Amazon’s uniqueness makes it challenging to define their core market, with diverse
rivals like Netflix in the streaming market as well as Google, Microsoft and IBM in the
cloud market ( ). This report will focus on their retail e-commerce market, with
its principal rival eBay as a benchmark to the industry.

1. Long-term Sources of Finances

( ) findings highlighted that companies seek the optimum capital structure, by

following a hierarchy or pecking order of sources. The order is crucial, any shifts in
the dynamics of the debt-to-equity making up the capital structure result in providing
signals to current and potential shareholders of the company ( ). ( ) states
managers favour internal sources. Whilst retained earnings is a limited source, it
negates the risks debts and equity brings, most importantly providing no troubling
signals of a financial crisis. However, if internal sources of finance are unavailable or
insufficient due to unstable profits or dividend policies, then external sources must be
explored, prioritising the most secure routes first.

Figure 1 – Pecking Order

( )

The next preferred available source is debt. Bank debt which are either loans or
overdrafts, without tradeable securities or market debt which are long-term bonds;
like debentures secured by assets or unsecured bonds which are payable against

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fixed interest rate ( ). Debt benefits from the tax-shield which can make it
cheaper than equity. However, there is the default risk of assets if they are secured
or bankruptcy to consider.

The final source of finance is equity where firms issue shares to raise funds ( ).
Firms can also opt for a rights issue, where current shareholders are invited to buy
more shares, which again is a limited source of finance. Unlike debt financing, there
is no risk of losing assets or bankruptcy, but there also is no tax-relieve available.
The signal it sends current and potential shareholders can be detrimental,
highlighting the use of a last-resort source of finance ( ). Depending on the value,
the market may translate that the firm is overvaluing or undervaluing shares, causing
investors to buy or sell at a rapid rate, leading to instability. Issuing shares will dilute
the control of current shareholders, but can also create two conflicting groups,
between the old and new shareholders, increasing costs if their conflicting views
demand changes. Before moving on to equity,( ) also suggests considering hybrid
sources. Hybrids like preference, convertible, cumulative, redeemable or
participative bonds or shares; each have a mix of trade-offs of both debt and equity,
thus recognised as more secure than pure equity.

Conversely, the Static Trade-off theory argues that there is no Pecking Order.
Instead, there is a set optimal target of debt-to-equity and firms steadily adjust to
achieve it ( ). The target considers the trade-off of debt, realising that
there is a point where the risk of default and bankruptcy outweighs the tax-shields
and ultimately costs of equity, suggests substituting debt with equity ( ). Equally,
substituting equity with debt when the trade-off outweighs the cost of debt, ensuring
combination creates the right balance of the two.

Amazon’s gearing ratio of 51.28% is within the ideal 40-60% range, which on its own
interprets that it is not at substantial risk of bankruptcy (Appendix 2A). With a YOY
5.34% decrease, the trend for risk seems to have lowered slightly by the end of
2016. Similarly, eBay’s gearing position is slightly lower at 47.31%, with the historical
trend of being either slightly higher or lower than Amazon’s ratio. This benchmarking
does indicate that Amazon gearing is roughly aligned with its main competitor in the
industry. While Amazon has some bank debt, it has significantly relied on both
secured and unsecured bonds financing their projects benefiting from tax-shields

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(Amazon, 2016). This would indicate that it is matched with the pecking order due to
the preference of using long-term bonds over equity. However, despite having the
ability to issue hybrid shares, the company still opted to raise capital using common
shares. This indicates that Amazon more likely sets an optimal target of debt-to-
equity, aligning attitude to risk more with the static trade-off theory.

2. Working Capital Management

Working Capital Management refers to balancing the firm’s current assets with
current liabilities ( ). It involves managers to satisfy two aims. Profitability by
investing in assets with the best returns for shareholders and liquidity to guarantee
financial commitments are met ( ). ( ) highlighted the contradictory relation
between the two, as maximising one is only possible at the cost of the other.

Figure 2 – WCC ( ).

Liquidity of the company shows the short-term risk and return characteristics. (
) developed an indirect measure of liquidity. The cash conversion cycle (CCC),
calculates the length of time the cash of day-to-day operations are tied up in
inventory, paying trade-payables or waiting for trade-receivables ( ). The shorter
and more aggressive the CCC is, the more liquid the firm becomes. While traditional
measures like current and quick ratios tests indicate how liquid a firm is, it is
criticised for being static and one-dimensional ( ). Figure 2 illustrates that the
working capital cycle (WCC) integrate several factors, building a more
comprehensive picture on how to improve the liquidity position. By following the CCC
formula, a firm understands if their credit policy with suppliers should extend or the

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credit policy with clients’ needs to be reduced to ensure a better liquidity position (
).

Based on the current ratio of 1.04, Amazon is efficient enough to cover their short-
term obligation but doesn’t show as strong confidence as its rival eBay who has an
ideal ratio of 2.31 (Appendix 2B). The quick ratio of 0.78 shows a more troubling
position with Amazon under the ideal of 1, indicating there is insufficient cash to
meet short-term obligations. There are no benchmarks available for any ratios
involving inventory as core competitors like eBay and Alibaba do not keep their own
inventory.

While the traditional measures highlight troubling liquidity, the CCC shows a more
efficient position. While there is no benchmark, Amazon’s CCC of -34.89 days is very
desirable. The negative number illustrates Amazon does not pay for inventory until
after they have received payment of goods, a highly efficient and aggressive cycle.
Amazon was able to increase their receivable days on YOY with an average of 22
days at the end of 2016 (Appendix 2B). This in comparison with eBay’s similar 25
days indicates that Amazon is slightly more efficient. This is further developed with
Amazon’s trade-payable days slight YOY increase to 105 days in comparison to
eBay’s sharp YOY 29% decrease to 51 days. The benchmark here indicates that
Amazon is twice as efficient than rivals in extending its payable bills. The liquid
position illustrates a lower risk in relation to short-term finance, with great returns due
to an aggressive cycle.

3. Dividend Policy
( ), or M&M, concluded that under specific assumptions dividend policies remain
irrelevant as it holds no effect on the current share price or value of returns. Firms
opting for no pay-out policies believe that dividends are irrelevant as shareholders
can raise capital with returns by selling their shares instead. ( ) underpin
irrelevancy theory upon perfect market assumptions which include equal access,
information asymmetry, no fees or taxes, the perfect confidence of profitability and
rational behaviour of feeling indifferent between cash and share value.

( ) themselves hint that there could be a signalling effect. As with the Pecking
Order theory, managers and directors are believed to have more information about

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the firm’s prospect of future cashflows and profitability, challenging information

asymmetry. ( ) further developed the notion of signalling, stating that steady
growth in dividends results in equal growth in share price. Likewise, a cut in
dividends as ( ) suggests, would in ( ) view result in an equal decrease in
share price and a signal that managers sense instability.

( ) assumption of indifference is challenged by the clientele-effect, where

investors are drawn to shares suiting their preferences in factors like tax-rate and
dividends returns ( ). ( ) study demonstrated that retired shareholders
preferred investing in high dividend shares, reducing their income-tax contributions.
Therefore, dividends are significant to give firms control to attract a certain type of
investors to become owners. Correspondingly, ( ) discovered that share price is
significantly influenced by dividends and that shareholders simply favour cash
dividends. The bird-in-hand theory stipulates that dividends steadily increasing not
only increases the value of the firm but also enables it to achieve higher ratings to
raise finance easier from the markets than firm not making payouts. While the
special rates and better facilities showcase a firm with a better ability to meet
financial obligations, ( ) does explain that firms must be aware of the risks of
dividends, within an uncertain market, and consider it when setting a dividend policy.

Amazon’s (2016) annual report clearly states that they have not declared or paid
dividends ever to shareholders. This is all based on their focus on reinvesting their
retained earnings straight back into new projects which increases the share price
and value (Amazon, 2016). The aim of the management is to create a company with
greater value instead of greater profits, reflected in their profitability ratios, promoting
higher risk characteristics. Amazons views that high profitability and dividends as a
priority would require changing to a short-term profitability model, over the long-term
returns focus Amazon (2016) currently models around. This would make Amazon
aligned with M&M (1961) irrelevance view, as they understand that due to the high
value of their shares, the investors they attract are favour value over cash dividends.
This is not unusual with eBay similarly stating never to have or planning to pay-out
dividends (eBay, 2016).

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4. Profitability & Risk

This section has been deleted but was 719 words and evaluated profitability,
risk (CAPM), business model (PEST) and Minsky analysis.

Summary
With the support of the literature discussed, it can be concluded that the low
profitability, use of the last source of the pecking order and lack of divided pay-outs
adds up to the high-risk characteristics. However, balanced out with the high value of
the company created with the support of those risks enabling investments in new
ventures and the aggressively efficient short-term finance with a negative CCC, there
are also high-returns characteristics which will continue to attract investors.

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Appendices

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Appendix 1A – Amazon Statement of Cash Position at 31 December 2016

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Appendix 1B – Amazon Statements of Comprehensive Income for the year ending 31

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December 2016

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Appendix 1C – Amazon Consolidated Statements of Financial Position for the year

ending 31 December 2016

Appendix 1D – eBay Statement of Cash Position at 31 December 2016

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Appendix 1E – eBay Statements of Comprehensive Income for the year ending 31

December 2016

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Appendix 1F – eBay Consolidated Statements of Financial Position for the year

ending 31 December 2016

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Appendix 2A – Gearing Ratio Calculations

Non-Current Liabilities
Shareholders’ Funds + Non-Current Liabilities
(Owner’s Capital)

Amazon 2015 Amazon 2016

(in millions) (in millions)

17,476 20,301 = 51.28% - 5.34% YOY

13,38 + 17,476 = 56.62% 19,28 + 20,301
4 5

eBay 2015 eBay 2016

(in millions) (in millions)

8,916 9,461
= 57.55% 10,53 + 9,461 = 47.31%
6,576 + 8,916
9

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Appendix 2B – Liquidity Ratio Calculations

Current Ratio

Current Assets
Current Liabilities

Amazon 2015 Amazon 2016

(in millions) (in millions)

35,705 45,781
= 1.05 = 1.04
33,887 43,816

eBay 2015 eBay 2016

(in millions) (in millions)

7,904 8,875
= 3.49 = 2.31
2,263 3,847

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Quick (Liquid) Ratio

Current Assets - Inventory

Current Liabilities

Amazon 2015 Amazon 2016

(in millions) (in millions)

35,705 – 10,243 45,781 – 11,461

= 0.75 = 0.78
33,887 43,816

eBay 2015 eBay 2016

(in millions) (in millions)

7,904 – n/a 8,875 – n/a

= n/a * = n/a*
2,263 3,847

* Unlike Amazon, eBay does not hold any inventory

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Appendix 2C – Working Capital Ratio Calculations

Inventory Days

Inventory x 365
Cost of Sales

Amazon 2015 Amazon 2016

(in millions) (in millions)

10,243 x 365 11,461 x 365

= 52.18 days = 47.39 days
71,651 88,265

eBay 2015 eBay 2016

(in millions) (in millions)

n/a x 365 n/a x 365

= n/a* = n/a*
1,771 2,007

* Unlike Amazon, eBay does not hold any inventory

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Receivable Days

Trade Receivables x 365

Sales

Amazon 2015 Amazon 2016

(in millions) (in millions)

5,654 x 365 8,339 x 365 + 16.02% YOY

= 19.29 days = 22.38 days
107,006 135,987

eBay 2015 eBay 2016

(in millions) (in millions)

619 x 365 592 x 365

= 25.16 days = 25.14 days
8,979 8,592

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Payable Days

Trade Payables x 365

Cost of Sales

Amazon 2015 Amazon 2016

(in millions) (in millions)

20,397 x 365 25,309 x 365

= 103.91 days = 104.66 days - 0.72% YOY
71,651 88,265

eBay 2015 eBay 2016

(in millions) (in millions)

349 x 365 283 x 365

= 71.93 days = 51.47 days - 28.44% YOY
1,771 2,007

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Cash Conversion Cycle

Inventory Days + Receivable Days – Payable Days

Amazon 2015 Amazon 2016

(in millions) (in millions)
52.18 + 19.29 – 103.91 = -32.44 Days 47.39 + 22.38 – 104.66= -34.89 Days - 7.55% YOY
eBay 2015 eBay 2016
(in millions) (in millions)
n/a + 25.16 – 71.93= n/a* n/a + 25.14 – 51.477= n/a *

* Unlike Amazon, eBay does not hold any inventory

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Appendix 2D – Profitability Ratio Calculations

ROCE

Profit before Interest and Tax

Shareholders’ Funds + Non-Current Liabilities
(Owner’s Capital)

Amazon 2015
Amazon 2016
(in millions)
(in millions)

2,233
4,186 + 3.33% YOY
13,38 + 17,476 = 7.24%
19,28 + 20,301 = 10.57%
4
5

eBay 2015 eBay 2016

(in millions) (in millions)
+ 2.73% YOY
2,406 3,651
= 15.53%
6,576 + 8,916 10,53 + 9,461 = 18.26%
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Net Profit Margin

Profit before Interest and Tax

Turnover

Amazon 2015 Amazon 2016

(in millions) (in millions)

2,233 4,186
= 2.09% = 3.08%
107,006 135,987

eBay 2015 eBay 2016

(in millions) (in millions)

2,406 3,651
= 28.00% = 40.66%
8,592 8,979

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Gross Profit Margin

Gross Profit
Turnover

Amazon 2015 Amazon 2016

(in millions) (in millions)

(135,987 – 88,265)
(107,006 - 71,651) = 34.73%
= 33.04% 135,987
107,006

eBay 2015 eBay 2016

(in millions) (in millions)

6,972
6,821 = 77.65% - 1.74% YOY
= 79.39% 8,979
8,592

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Capital Turnover

Turnover
Total Assets – Current Liabilities

Amazon 2015 Amazon 2016

(in millions) (in millions)

107,006 135,987
= 3.47 times = 3.44 times
64,747 – 33,887 83,402 – 43,816

eBay 2015 eBay 2016

(in millions) (in millions)

8,592 8,979
= 0.55 times = 0.45 times
17,755 – 2,263 23,847 – 3,847

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Appendix 2E – Beta Capital Asset Pricing Model Calculations

rs = rf +(rm-rf)β

Amazon 2016

 15.59% = 2.45 +(11.9-2.45) 1.39

eBay 2016

 11.05% = 2.45 +(11.9-2.45) 1.17

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References

21 references cited

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