Question 4FSAC - Intermediate Accounting (Kieso)

Question

Case 4: Amazon.com The incredible growth of Amazon.com has put fear into the hearts of traditional retailers. Amazon’s stock price has soared to amazing levels. However, it is often pointed out in the financial press that it took the company several years to report its first profit. The following financial information is taken from a recent annual report.

(\( in millions)	Current year	Prior year
Current assets	\)31,327	$24,625
Total assets	54,505	40,159
Current liabilities	28,089	22,980
Total liabilities	43,764	30,413
Cash provided by operations	6,842	5,475
Capital expenditures	4,893	3,444
Dividend paid	0	0
Net income (loss)	(241)	274
Sales	88,988	74,452

 

Instructions 

(a) Calculate free cash flow for Amazon for the current and prior years, and discuss its ability to finance expansion from internally generated cash. Thus far Amazon has avoided purchasing large warehouses. Instead, it has used those of others. It is possible, however, that in order to increase customer satisfaction, the company may have to build its own warehouses. If this happens, how might your impression of its ability to finance expansion change? 

(b) Discuss any potential implications of the change in Amazon’s cash provided by operations from the prior year to the current year.

Step-by-Step Solution

Answer

1. Company cannot finance its expansion.
2. Increase in current liabilities might be the reason for the increase in cash provided by operations.

Definition of Internal Financing

The process under which the business entity finances its business expansion through the use of its profit and assets is known as internal financing.

Calculation of free cash flow

Particular	Current Year	Prior Year
Cash provided by operations	$6,842	$5,475
Less: Dividend paid	0	0
Less: capital expenditure	(4,893)	(3,444)
Free Cash Flow	$1,949	$2,031

The data presented above reflects that the company’s profitability is declining and an increase in cash from operations. The increase in cash from operation might be because of an increase in current liabilities 

Implications of increase in cash provided by operations

The increase in cash from the operation is because of the following reason:

1. Net increase in working capital.
2. Non-cash income adjustment.
3. Increase in current liabilities.