November 4, 2009

How long can Amazon.com put off paying its bills?

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A Wall Street Journal report by Martin Peers (http://online.wsj.com/article/SB125682780621816085.html?mod=WSJ_hpp_LEFTTopStories) details some of the secret tactics used by Amazon.com, a company which has never made a profit, to control the book industry by simply delaying payment of its debts , as says Dennis Johnson at MobyLives.

According to Peers, it isn't a secret that Amazon's financial success is partly based on its ability to take in money for selling merchandise before it has to pay its suppliers.

But lately Amazon has gone one better: «steadily lengthening the time it takes to pay suppliers. That has been a factor behind the retailer's soaring cash flow.»

Amazon has lengthened is “account-payable” delays — 30 days for most of the known world — from an initial 49 days in 2003 to 72 days today.

As Brian Evans, an analyst for research firm Behind the Numbers, notes, this "theoretically means that Amazon has not paid suppliers for sales consummated in mid-June." Amazon's sales rose 28% in the quarter, but accounts payable nearly doubled, helping push free cash flow up 116%.

Averaged through the year, «Amazon's accounts-payable days have risen from 49.25 days in 2003 to 59 last year before jumping this year to an average of 64.6. Free cash flow has risen to $1.36 billion in 2008 from $346 million in 2003», says Peers.

Such efficient working-capital management is to be envied. But investors shouldn't get too used to it. Amazon can't keep extending payment terms with its vendors indefinitely. When it stops, one source of free cash-flow growth will disappear, stresses Martin Peers.

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Charles Mulford, an accounting professor at the Georgia Institute of Technology, notes how sharply boosting accounts payable helped Robert Nardelli transform Home Depot's cash generation after he took charge at the end of 2000. The retailer went from reporting negative free cash flow to $2.57 billion in fiscal 2002. But gains from working-capital efficiency petered out.

Such things won't flow Amazon's way forever.

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How long can Amazon.com put off paying its bills?