A balance sheet is a financial statement that reflects what a business owns (assets), what it owes outsiders (liabilities), and its owners (equity). It balances the accounting equation by equating assets to the sum of liabilities and owners’ equity (Fraser & Ormiston, 2015). It shows a company’s financial condition or position at a specific date, considering that the balances of assets, liabilities, and equity can change materially from one day to another.
The working capital or current ratio is calculated by dividing current assets by current liabilities. The current ratio is a liquidity test for any business. Amazon’s current assets and liabilities were 96,334 and 87,812 million, respectively. Therefore,
Accounts receivable turnover is an indicator of a company’s efficiency in using assets, operational and financial performance, and credit policies’ effectiveness. The ratio is calculated by dividing annual credit sales by average accounts receivable. The average accounts receivable for Amazon equals (16677 M + 20816 M) = 18746.5 M (Amazon, 2019). Therefore,
The allowance for doubtful accounts is also important as it affects the value of accounts receivables and bad debt expense on the balance sheet and income statement, respectively. Amazon’s allowance for bad debt is calculated as follows:
Equipment and property are considered tangible long-term assets because they have a physical form and offer economic benefits for over a year (Fraser & Ormiston, 2015). According to Amzon (2019), equipment includes networking equipment, servers, fulfillment equipment, and heavy equipment, while property comprises land and buildings. Amazon uses the straight-line method to calculate amortization and depreciation with a useful lifespan of 40 years for buildings, “three years for servers, and five years for networking equipment, ten years for heavy equipment, and three to seven years for other fulfillment equipment” (Amazon, 2019, p. 46). The depreciation method used and useful lifespan allocated to equipment and property affect the value of assets reported on the balance sheet and the depreciation expense indicated on the income statement.
A company’s debt to equity (D/E) ratio indicates whether the business can use its funds to service all its debts in an economic downturn. The D/E ratio is calculated by dividing total liabilities by total equity (Carlson et al., 2020). Therefore, Amazon’s D/E ratio equals
Amazon’s Strengths and Weaknesses
Amazon presents a weak current ratio, considering that the retail industry’s best ratio should lie between 1.2 and 2.0. The 1.1 current ratio shows that the company might struggle to meet its short-term obligations. According to Myšková and Hájek (2017), a working capital ratio of 1.5 and above reflects a company that does not have problems meeting its short-term debt needs. Therefore, Amazon is weak in terms of liquidity and might be struggling to pay its short-term debts or might be exhausting its current assets.
On the other hand, Amazon has strength in collecting credit sales from the customer, with a 14.96 turnover ratio. The value shows that the business collects from customer accounts every month. Additionally, the company has allocated only 3.33% of its receivable to doubtful accounts, reflecting efficiency in payment collection and effective credit policies (Myšková & Hájek, 2017). The company quickly collects from customers to keep the company’s working capital at desired levels.
Amazon has the advantages and disadvantages of using the straight-line method of depreciation for its equipment and property. The method shows better profits throughout the asset’s life than the accelerated method that would lead to decreased income in the first years of the equipment’s life (Carlson et al., 2020). The depreciation method is, therefore, a strength for Amazon as it can mask poor financial performance.
Amazon is strong in financing its operations using its resources as compared to using debt. The D/E ratio of 0.72 reflects a healthy business, running on its funds rather than borrowing to survive. However, that could change if preferred shares were classified as debt instead of equity (Myšková & Hájek, 2017). Conclusively, the organization is doing well in minimizing the use of debt.
Recommendations
Comparing Amazon’s financial information against the industry data, I would advise my friend to invest in the company after watching its working capital changes for at least two quarters. The industry’s current ratio ranges from 1.14 to 1.29 since 2014, according to Ready Ratios (n.d.). Amazon’s ratio falls slightly below the 2019 industry average value to record 1.1. Therefore, my friend should watch how this ratio progresses over six months and invest if it increases.
On the other hand, if my friend wants a long-term investment, Amazon will meet all the criteria. It has excellent credit policies and payment collection abilities because it surpassed the industry average of 9 days accounts receivable turnover by 5.96 (Ready Ratios, n.d.). Additionally, Ready Ratios (n.d.) reported an industry average of 1.74 D/E ratios while Amazon recorded 0.72 the same year. The lower ratio implies that the company does not rely on debt and it has enough equity to continue operating amid difficult economic times. In conclusion, I advise my friend to invest in Amazon for the long-term, expecting positive returns over five years.
References
Amazon. (2019). Annual report [PDF document]. Web.
Carlson, M. A., D’Amico, S., Fuentes-Albero, C., Schlusche, B., & Wood, P. R. (2020). Issues in the use of the balance sheet tool. FEDS Working Paper, 071. Web.
Fraser, L. M. & Ormiston, A. (2015). Understanding financial statements. Pearson Education.
Myšková, R., & Hájek, P. (2017). Comprehensive assessment of firm financial performance using financial ratios and linguistic analysis of annual reports. Journal of International Studies, 10(4). Web.
Ready Ratios. (n.d.). Retail trade: Average industry financial ratios for U.S. listed companies. Web.