Financial ratios are important and accurate instruments of company performance evaluations, which provide substantive data on whether or not a particular company is an attractive investment opportunity. It is stated that “a financial ratio is simply one number from a financial statement that has been divided by another financial number” (Parrino et al., 2017, p. 222). In other words, financial ratios are simple measurement instruments that reveal information about a specific aspect of a business. The given analysis will derive the ratios from the 2021 Annual Report by Amazon. A wide range of financial ratios can be divided into four main categories relevant for the given ratio analysis of Amazon, which includes liquidity, efficiency, leverage, and profitability.
The liquidity category is indicative of how quickly a company’s assets can be turned into readily available cash. The liquidity ratio is measured with the use of current and quick ratios (Parrino et al., 2017). For example, the current ratio for Amazon is 1.14, which indicates lower levels of liquidity since the desired range is around 1.5. In other words, the company is not capable to converts its assets into cash easily and swiftly. For instance, the quick ratio for Amazon is 0.91, which is relatively closer to the desired value of 1 or greater (Parrino et al., 2017). The value means a healthy business with the capability to pay out its liabilities if necessary. In the case of comparisons with the industry ratios, it is evident that Amazon has higher levels of liquidity compared to other competitors, except for a poorer ability to meet short-term debt obligations.
The liquidity of an enterprise it has working capital in an amount theoretically sufficient to repay short-term obligations, even if they do not meet the maturity dates stipulated by contracts. Paying capacity means that the enterprise has cash and cash equivalents sufficient to pay for accounts payable requiring immediate repayment. Thus, the main signs of solvency are sufficient funds in the current account and the absence of overdue accounts payable. In general, the current ratio is all less than 1.5, which means that the liquidity of the organization is low, whereas the debt-to-equity ratios are high. These two indicate a higher risk of the financial state of Amazon, but it is considered normal for the given industry. The financial strength of the company is the growth of its profitability despite the pandemic, but the weakness is the lower return on invested capital.
The efficiency ratio is another important financial indicator of performance. It is stated that it measures “how efficiently a firm uses its assets” (Parrino et al., 2017, p. 227). The core formulas include fixed asset turnover, total asset turnover, day’s sales outstanding, account receivable turnover, day’s sales in inventory, and inventory turnover (Parrino et al., 2017). For example, the latter for Amazon is 8.3, which is good since no investment remains in the inventory for too long. In addition, the asset turnover for the company is 1.11, which “measures the dollar amount of sales generated with each dollar of total assets” (Parrino et al., 2017, p. 231). For such a large company, the given value can be considered acceptable since sales are generated well from the existing assets. When it comes to receivable turnover ratios, it is equal to 22 days, which means that it takes this amount of time to turn sales into cash. In the case of comparisons with the industry ratios, Amazon is as efficient as its main rivals. The reason is that the industry has little flexibility in terms of efficiency category.
Moreover, another key financial ratio category is comprised of leverage ratios. It is stated that “leverage ratios measure the extent to which a firm uses debt rather than equity financing and indicate the firm’s ability to meet its long-term financial obligations, such as interest payments” (Parrino et al., 2017, p. 232). The core formulas include cash coverage, times interest earned, equity multiplier, debt-to-equity ratio, and total debt ratio (Parrino et al., 2017). By assessing all of these values, it can be stated that Amazon is in a good position in terms of its long-term solvency. For instance, the interest coverage ratio for the company is 22.09, which is exceptionally desirable since Amazon is fully competent at meeting the imposed payments on interests. In other words, it is able to pay off its debts in the long run, and it has more assets compared to its debt.
When compared to the industry, Amazon is in a leading position for its leverage, even if its financing relies on a debt too much. For example, the debt-to-equity ratio is 1.55, which indicates that the source of financing for assets is coming from debt more than equity. Therefore, it is possible that the company is relying on its existing capability to pay off its debts in the long term. The market might not be as eager to invest in Amazon, which can limit the equity influx of funds, which is why debt is the only option to sustain growth.
Lastly, the financial ratio category of profitability measures how lucrative the business is within its ability to generate profit. It is stated that “these measurements are of interest to stockholders, creditors, and managers because they focus on the firm’s earnings” (Parrino et al., 2017, p. 237). The measurements for the assessment were done by using the formulas such as return on equity, return on assets, EBIT return on assets, net profit margin, operating profit margin, and gross profit margin (Parrino et al., 2017). The evaluation showed that Amazon excels in all regards when it comes to how profitable the company is as an investment. For example, the net profit margin after taxes is equal to 7.1%, which is not outstandingly high but significant considering the size and volume of sales. The gross margin of 14.1% additionally supports the high lucrativeness of the corporation. However, by reflecting on all measurements, one can state that Amazon is a good and profitable investment. When compared with average industry values, the company has better profits when taxes and other expenses are accounted for but lower lucrativeness if one looks at the gross margin.
In conclusion, it should be noted that financial ratios are critical and accurate instruments of company performance evaluations. They provide substantive information on whether or not a particular company is an attractive investment opportunity. Thus, financial ratios are effective and simple measurement tools, and they can show specific aspects of a business. The given analysis derived the ratios from the 2021 Annual Report by Amazon. The focus was put on liquidity, efficiency, leverage, and profitability ratio categories.
Parrino, R., Bates, T., Gillan, S. L., & Kidwell, D. S. (2017). Fundamentals of corporate finance (4th ed.). Wiley.