As a Certified Public Accountant, I get asked the same questions from my clients each year. “Why are my taxes so high?” is the most popular one, with “Why are your fees so high?” a close second. But another question that frequently gets asked has to do with a client’s financial statements. It’s “What do you think my company’s worth?”
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That’s a tough one.
It used to be simple. As an accountant, I generally point the client to their balance sheet and explain that a good measure is stockholder’s equity. That number is supposed to represent what a company would be left with if they sold off all their assets and paid off their liabilities with the proceeds. But of course that’s not all. Some assets may be worth more than the cost value shown on their balance sheet. And there’s always goodwill, which is an extra amount a buyer would pay representing an intangible value of worth also not shown on the balance sheet. Some companies look to value themselves using a multiple of cash flow or earnings. This is all well and good for a private company. But what happens when you’re a public company? Well, you might as well throw your financials out the door.
And for this, you can thank Jeff Bezos. He’s ruined financial statements.
Bezos’ company, Amazon.com, releases earnings this week. If someone were to ask me, a CPA, to evaluate Amazon based on their audited financial statements I wouldn’t be very impressed. Sure, the numbers are large. But the percentages aren’t.
In 2014, Amazon’s operating income was $178 million on revenues of $89 billion, or .2%. In years prior operating income was higher, coming in at around 1% of revenues in 2013, 2012 and 2011. The company is barely making money! Amazon’s balance sheet is even less impressive. At the end of last year its current assets of $31 billion were almost eaten up by $28 billion in current liabilities. A healthy current ratio is more like 2:1. Amazon’s equity at the end of last year was about $11 billion. The financials aren’t great. And yet the stock market values them at more than $250 billion! None of this makes sense to my hard-working clients. I get it.
And so does Jeff Bezos. When asked about Amazon’s profitability, Bezos usually points to the company’s free cash flow, which is impressive. He explains about market share and the investments being made in cloud services and infrastructure. He reminds us of his company’s e-commerce dominance. And he’s absolutely right. Amazon’s value has nothing to do with its financial statements. And neither does the stock market. Alphabet (that’s Google), for example, earns way more money than Amazon as a percentage of sales (in 2014 for example, the company earned about $14 billion on revenues of $66 billion or an impressive 21%). But does that explain why the company’s market value is more than five times its shareholders’ equity? Even Macy’s, a retailer (kind of) similar to Amazon had earnings before income taxes which ranged about 5-8% of revenues over the past few years yet has a market value more than twice its last year’s equity.
Jeff Bezos runs a public held company and for decades investors in these companies don’t rely too much on financial statements when it comes to how much they think a company is worth. Which is why stock prices can significantly fluctuate and small business owners and CPAs scratch their heads wondering what’s going on.
If you’re running a small business, one of the hardest things to understand is that the value of your company is not reflected in your financial statements. Jeff Bezos knows this. He knows that the past does not dictate the future. He knows that his current and future investors aren’t interested so much in what happened. They’re interested in what’s going to happen. If a client of mine is valuing his company merely based on what showed on his balance sheet at the end of last year he’s making the wrong valuation. Of course, tangible assets like inventory and equipment are important to a prospective buyer. And a history of earnings helps. But what savvy investors really want to see in your company are the things that are not in your financial statements: your future orders, sales pipeline, organizational structure, management team, the investments being made that will pay off in the future.
Are your financial statements useless? It used to be that a financial statement was the bedrock supporting a company’s value. But Jeff Bezos and Wall Street has ruined that. Sure, they’re useful for a bank loan or a tax return. But by the time they’re prepared they’re ancient history. And the people who invest don’t care as much about history as they do about the future.