Jeff Bezos never focused on earnings, EPS, or "profit".
Why? He knows those numbers are flawed.
Here are 3 key reasons why he focused EXCLUSIVELY on free cash flow:
Why? He knows those numbers are flawed.
Here are 3 key reasons why he focused EXCLUSIVELY on free cash flow:
Flaw #1: Depreciation
Accounting rules dictate that equipment must be expensed over a number of years via depreciation.
The problem is this does NOT match the cash outflow when Amazon buys equipment.
Accounting rules dictate that equipment must be expensed over a number of years via depreciation.
The problem is this does NOT match the cash outflow when Amazon buys equipment.
Flaw #2: Cost of Goods Sold
Accounting rules dictate that Amazon expense inventory via Cost of Goods Sold
However, this does NOT match the cash outflow that Amazon incurs when it buys inventory.
Accounting rules dictate that Amazon expense inventory via Cost of Goods Sold
However, this does NOT match the cash outflow that Amazon incurs when it buys inventory.
Flaw #3: Accounts Receivable
Accounting rules dictate that Amazon has to record sales on credit as revenue.
However, this does NOT match the cash inflows that Amazon receives when it collects cash for sales on credit.
Accounting rules dictate that Amazon has to record sales on credit as revenue.
However, this does NOT match the cash inflows that Amazon receives when it collects cash for sales on credit.
In essence, "Profit" is measured using Accrual accounting.
Accrual accounting is like an accountant's opinion of how much money the company earned.
Bezos vastly prefers Cash accounting, which only measures when cash changes hands.
Accrual accounting is like an accountant's opinion of how much money the company earned.
Bezos vastly prefers Cash accounting, which only measures when cash changes hands.
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The best way to measure profits using cash accounting is by measuring Free Cash Flow.
The Free Cash Flow formula is simple:
Operating Cash Flow - Capital Expenditures (Capex)
The Free Cash Flow formula is simple:
Operating Cash Flow - Capital Expenditures (Capex)
Why is βCapexβ deducted from Operating Cash Flow?
Operating Cash Flow doesnβt take into account the cash spent to buy assets like buildings, equipment, and computers.
For many businesses, Capex is an ongoing cost of doing business.
Operating Cash Flow doesnβt take into account the cash spent to buy assets like buildings, equipment, and computers.
For many businesses, Capex is an ongoing cost of doing business.
Here is a chart that compares Amazon's profit, cash flow, and free cash flow over time
Notice that Amazonβs cash flow and free cash flow are higher than profit almost every year.
Notice that Amazonβs cash flow and free cash flow are higher than profit almost every year.
Amazon takes big depreciation charges, which reduces profits.
These charges are for assets that Amazon invests to build its business.
This causes a mismatch that makes profit appear low.
This is why Bezos focuses on Free Cash Flow, not Profits.
These charges are for assets that Amazon invests to build its business.
This causes a mismatch that makes profit appear low.
This is why Bezos focuses on Free Cash Flow, not Profits.
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