Amazon, Inc.

, Part II:
Profitability and Ratio Analysis 1

As an analyst for the technology sector, you cover Amazon.com, Inc. You have done a substantial
“deep dive” into Amazon, understanding all aspects of their operations, strategy, and performance.
In the course of your analysis, you obviously realize that Walmart, Inc., the world’s largest retailer,
is a substantial competitor to Amazon. However, Walmart is covered by the retail sector analyst
in your firm. The two of you decide that it would be useful to work together to better understand
and compare the two companies if you were truly going to be able to understand either one of
them. The two of you agree to meet tomorrow, so unfortunately you do not have much time to
prepare. Fortunately, you recall the key parts of a company’s annual report from your financial
statement analysis MBA class so you can efficiently gain some quick insights.

You come up with the following high level game plan:

1. Download Walmart’s fiscal year 2019 annual report and get familiar with the key sections
related to financial performance:
a. Letter to shareholders
b. Item 1: Business
c. Item 7: Management’s Discussion and Analysis of Financial Condition and Results
of Operations
d. Item 8: Financial Statements and Supplementary Data
2. Integrate Walmart’s financial results into your Amazon profitability analysis spreadsheet
so that you can easily compare the performance of the two companies.
3. Use your knowledge of Amazon and the information you gleaned about Walmart from
their annual report to provide explanations for the differences in the two companies’
profitability and why they are changing over time.

Overview: In this case, we analyze the performance of Amazon and compare it to one of its major
competitors, Walmart, Inc. In Part I we examined various qualitative factors potentially affecting
Amazon’s performance, such as corporate strategy, competition, and product lines. We saw that
the 10-K (annual report) provides substantial insight into these factors. In this assignment, we link
these qualitative factors to quantitative performance. To do this, we will use several commonly
used financial statement ratios to help us understand and compare Amazon’s and Walmart’s
profitability, efficiency, and asset utilization and see how these factors are changing over time. We
will see that both differences in strategy and differences in accounting affect these ratios and our
interpretation of a firm’s performance.

Learning objectives: By the end of this assignment you should be more familiar with:
1. Connecting financial statements to management, industry and strategy.
2. Knowing how to calculate traditional financial statement analysis tools:

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This case was prepared by Michael Minnis and Abbie Smith at the Booth School of Business at the University of
Chicago. This case was produced for illustration purposes only and is not intended to establish valid predictions of
firm performance.
 Amazon, Inc., Part II: Profitability and Ratio Analysis

a. Common size financial statements

b. Trend statements
c. DuPont Framework for profitability analysis
3. Knowing how to interpret these ratios, including issues limiting the comparability of ratios
(across firms or over time) and potential ratio distortions associated with GAAP financial
statements and one-time items.

Materials: This assignment includes four files:

1. This PDF case document.
2. Excerpts from Walmart’s 2019 fiscal year annual report.
3. A Word document which exclusively includes the questions that you need to answer, but
allows you to simply type your brief responses into this Word document, save, and submit
to Canvas.
4. An Excel spreadsheet (Amazon Profitability Analysis – Part II.xls) which includes
historical financial statement information for Amazon—and for comparison, Walmart.
You need to calculate the ratios in this spreadsheet as directed below and submit the
completed Excel spreadsheet to Canvas.

Assignment: Use the answers to Amazon, Part I, Amazon’s annual report, the Amazon
Profitability Analysis spreadsheet, and excerpts from Walmart’s 2019 fiscal year annual report to
complete the spreadsheet and answer the case questions.

You have two items to submit:

1) Spreadsheet: You need to complete the spreadsheet accompanying the case (Amazon
Profitability Analysis – Part II.xls). This spreadsheet includes the financial statements for both
Amazon and Walmart and you will note that much of the spreadsheet has been completed for
you. You only need to complete the yellow highlighted cells.

2) Short answer questions: Answer the questions below (written in italics). These questions have
been included in a separate Word document which needs to be submitted. Keep your responses
brief! Just answer exactly what the question is asking and be prepared to discuss in class.

Some pointers to guide you through case

Here is a high-level step-by-step recipe to guide you.

1. Read. Peruse the excerpts of Walmart’s 2018 fiscal year annual report (for the year ended
January 31, 2019 which we will compare to Amazon’s fiscal year 2018 which ended
December 31, 2018). 2 Note that even though this is only an excerpt of the annual report, it
is still more than 50 pages long. Do not read every word, but instead get a good sense of
what Walmart does, what its strategy and objectives are, and how it operates. In particular,
note that Walmart, like Amazon, has different operating segments. Make a note to yourself
of what those segments are and if you see differences between them. Also note that for
completeness I have included the entire set of financial statements and footnotes. For this

2
Walmart refers to the year ending January 31, 2019 as fiscal year 2019, but because most of this fiscal year falls into
calendar year 2018 and because we will be comparing Walmart’s year ending January 31, 2019 to Amazon’s fiscal
year ending December 31, 2018, we will call these years “2018” for both companies.

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case, the most relevant footnotes are “Note 1: Summary of Significant Accounting
Policies” (think, in particular, about what types of expenses go into which line items and
how this might affect your thinking about gross margins versus operating margins for these
two companies) and “Note 15: Segments and Disaggregated Revenue.” You may want to
peruse the remaining notes, but remember you do not need to be the expert on Walmart
(this is your colleague’s job), but instead you are trying to understand how Walmart is
performing.

2. Basic DuPont Analysis. After getting familiar with Walmart’s annual report excerpts,
open the Amazon Profitability Analysis spreadsheet. Flipping through the tabs you will
notice that the income statements and balance sheets for both companies are pre-loaded
(yellow tabs). I have also provided tabs for “common size” financial statements for both
companies (brown tabs). There are also three (blue) tabs relating to the Basic DuPont
profitability analyses. The first tab includes the definitions of each of the ratios to be
calculated. The next two tabs include “flow charts” decomposing Return on Common
Equity (ROCE) into different components. I have completed this analysis for Amazon and
for Walmart’s 2017 year. You need to complete the analysis for Walmart’s for 2018 FY.
The cells that need to be completed are shaded yellow. Use the definitions tab and the
formulas for Walmart in 2017 to help you derive the calculations. Finally, you will see a
“Profitability Analysis Summary” (green tab) at the end of the spreadsheet. This table pulls
together all of the profitability flow chart data into one place to make it easier for you to
compare the performance of both companies over time and against each other. The
formulas for most of these items are already complete (or reference other tabs), but you
need to derive the formulas for the yellow shaded tabs. Use this data to answer the questions
in the text below about the analysis.

3. Advanced DuPont Analysis. Finally, you will analyze both companies using the
Advanced DuPont decomposition. While many of you have likely seen the ratios used in
the Basic DuPont analysis, the ratios and approach used in the Advanced approach may be
new. The text below helps you to first re-allocate the income statement and balance sheet
and then construct the ratios in the flow charts. Again, I have done Amazon’s for you.

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 Amazon, Inc., Part II: Profitability and Ratio Analysis

BASIC DUPONT PROFITABILITY ANALYSIS

Before analyzing and decomposing profitability, one of the most straightforward (and sometimes
most useful) tools to get started is to conduct a “common size” analysis. To do this, divide all
financial statement line items by a common denominator. For the income statement, revenues are
typically used as the denominator; while for the balance sheet total assets are typically used. After
“common sizing” the financial statements, they are easier to compare across years. I have already
created the common size financial statements for you in the spreadsheet. Examine these for both
companies and then answer the following questions.

1. What accounts on the income statement are changing the most? What is happening to
Amazon’s gross margins? What is happening to Amazon’s net income margin? What about
Walmart – do you see as much change?

2. What accounts on the balance sheet for Amazon are changing the most? Why do you think
these accounts are changing? Is this consistent with what we discussed in Part I of the case?
There are only three non-equity balance sheet accounts which changed by more than 4
percentage points for Walmart. One event changed all three accounts – what happened?

The basic DuPont Profitability decomposition analysis begins by calculating return on common
equity (ROCE) to assess the rate of return on capital invested by the common stockholders (i.e.,
income available to common stockholders per dollar of common stockholders’ equity). We can
then “decompose” ROCE into different components for further insights. The purpose of an ROCE
decomposition is to see what makes the company “tick” – why is it so profitable or why is it
struggling? For example, is ROCE high because it has great profit margins? Is it because it uses
assets efficiently? Or maybe the company is simply highly levered (and, therefore, potentially
taking on more risk).

As a first step in analyzing the drivers of ROCE, it is decomposed into the product:

ROCE = ROA x Leverage

ROA (return on assets) reflects the after tax income (before interest expense after tax) per dollar
of assets. It includes all income in the numerator, and all assets in the denominator, and reflects
the profitability of the assets. Unlike ROCE, ROA strips away most the differences between
companies related to differences in debt vs. equity financing (i.e., the extent of financial leverage)
in the firm’s capital structure (but not all differences as we will see later).

3. Is the increase in Amazon’s ROCE in 2018 due to an increase in ROA, Leverage, or both?

4. Compare the change in Amazon’s ROCE in 2018 to the change in Amazon’s ROA. Why is the
change in Amazon’s ROCE so much higher than the change in its ROA?

5. By contrast, Walmart’s ROCE dropped in 2018. Is this caused by a decrease in ROA, Leverage,
or both?

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 Amazon, Inc., Part II: Profitability and Ratio Analysis

Next, we can get further insights into ROA by decomposing into the product of two factors:

ROA = Profit Margin x Total Asset Turnover

The Profit Margin (PM) reflects the after tax income (before interest expense after tax) per dollar
of sales (how profitable is a dollar of sales on average); and Total Asset Turnover (TAT) reflects
the sales per dollar of assets (how many dollars of sales can the firm generate for an average dollar
of assets).

6. Amazon’s and Walmart’s ROAs went in opposite directions in 2018. Were these changes
caused by changes in Profit Margin, Total Asset Turnover, or both?

We will now explore both profit margins and total asset turnover in greater detail to understand
why these ratios are changing and link them to qualitative insights.

Profit Margin Analysis

To get further insights into profit margins and changes therein, we next assess individual revenues
and expenses. To do this, we will use more detailed financial information provided from the annual
reports. Note that Profit Margins are affected not only by prices and costs, but also by business
strategies, product mix, life cycle, macroeconomic conditions, unusual gains or losses, financial
income, effective tax rates, and accounting policies.

Segment and product mix

We will start with a review of how Amazon has been changing its product mix. In Amazon’s
financial statements, go to “Note 10: Segment Information” and read the brief descriptions of
each segment. You will also note that Amazon has several tables in Note 10 which break down
Revenues, Operating expenses, and Operating income into different segments and
products/services. Use this information to answer the following questions.

7. How has Amazon’s revenue mix of product sales vs. service sales changed in recent years?

8. What accounted for the substantial increase in sales from physical stores in 2017? In 2018?
What is “distorted” about the growth rate in sales from physical stores in 2018?

9. What product/service group (besides physical stores) has the highest growth rate in 2018?
What revenue stream is driving this?

10. BONUS QUESTION: Part of the growth in the “Subscription Service” line item is driven by
an accounting change. What is it? [Hint: See pg. 48 of the 2018 10-K for a description of
Amazon’s accounting policies for revenue recognition.]

11. Is there a trend in the gross profit % (“gross margin”) reported in Amazon’s common size
income statements? How is Amazon’s gross margin affected by the change in revenue mix of
product vs. service sales? [Hint: What is the gross margin percentage for services-based
revenues?]

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12. Is there a trend in Amazon’s operating income % (“operating margin”)? How did the
operating margin change in 2018?

Now open Walmart’s financial statements and go to “Note 15: Segments and Disaggregated
Revenue.” Read the brief description of how Walmart segments its operations and peruse the
tables to answer the following questions.

13. Compare the mix of revenues and gross margins of Amazon vs. WMT. Do the differences in
gross margins make sense in light of their different mix of businesses, products and services?
In particular, consider the following: what is Walmart’s biggest merchandise category? Using
what you know about that segment, are margins expected to be high or low for Walmart’s
largest merchandise category?

14. Compare the total operating expenses (excluding COGS) as a percentage of sales of the two
companies. What type of expenses contribute most to these differences?

15. Compare the operating margins from the common size income statements of the two
companies. Recall from the analysis of Amazon’s operating margins, the operating margin on
Amazon’s AWS segment was by far the highest of its three segments. To better understand the
operating margins of Amazon vs. WMT, use the segment disclosures data to calculate
Amazon’s operating margin for North America and International only (i.e., excluding AWS
and corporate overhead allocations). How does this adjusted value compare to WMT’s 2018
operating margin?

Scale effects (“Expense leverage”)

In contrast to variable costs, fixed costs do not increase proportionately with sales. Components
of an operating expense that are fixed contribute to “expense leverage” whereby sales (and
operating income) increase more rapidly than the operating expense.

16. Which operating expenses do you expect to grow less rapidly than sales (i.e. have a significant
fixed cost component)? The excerpt below from Amazon’s MD&A may be helpful:

Competition and competitive strategies

Both companies face intense competition in their retail businesses (including fierce competition
from one another), and are responding by lowering prices further (reduces profit margins). In
contrast to WMT’s focus on retail, Amazon pioneered the highly innovative, high margin cloud

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business. Although Amazon’s AWS has reduced prices in response to an increase in competition
(e.g. Microsoft), it remains a high margin business. WMT has focused on the low margin grocery
business and tends to offer “value products” rather than high end merchandise. Amazon’s
selection is across the board.

Life cycle
It is still “Day 1” at Amazon. Amazon continues to grow revenues organically through the
development of new products and services, new geographic markets, marketing, technology etc.
Although the company has been in business for more than two decades, in many ways it is in the
early stages (lowers profit margins). In contrast, WMT is a mature, established, successful global
brick and mortar business. All else equal (e.g. competition) going from the early to mature stage
of a business often is associated with an improvement in profit margins (e.g. economies of scale,
established brands and markets etc.). One caveat is that WMT’s is in the early stages of its e-
commerce / omni-channel transformation, and as a result and is incurring technology and other
expenses (lowering profit margins). Down the road when the level of expenses related to this
transformation subsides, the profit margin can be expected to improve to the extent it is not offset
by lower gross margins from a shift in product mix (like the negative gross margin effect of
ecommerce sales WMT’s MD&A described for 2018 and 2019).

Macroeconomic conditions
Changes in currency exchanges rates did not materially affect the profit margins of either
company (MD&A). Both companies worry about regulatory and other policy effects (e.g., health
care).

Unusual gains or losses

WMT highlights on the 2018 income statement an $8.4 B “Other Loss”. The notes clarify that
this loss includes a $3.5 B decline in the fair value of its equity investment in JD.com and a $4.8
B loss ($4.5 B after-tax) associated with its sale of 80 percent of Walmart Brazil. Given the
magnitude of these items, it is worth considering WMT’s profit margin (as well as ROA and
ROCE) both with and without the inclusion of these losses.

To compute the profitability ratios without the losses, one can adjust the reported net income by
adding back the after-tax losses. While the after-tax loss of $4.5 B is clear in the notes, the after-
tax effects of the $3.5 loss in value of from its equity investment in JD.com is uncertain.
However, Note 7 – Fair value measurements, suggests that the entire $3.5 B loss was recognized
in net income, so as a reasonable approximation one can adjust reported net income by adding
$3.5 B + $4.5B.

With these adjustments, the adjusted profit margin is 3.4%, with an adjusted ROA of 8.2%,
adjusted leverage of 2.4, and adjusted ROCE of 20.0%, making Walmart’s ongoing performance
substantially more similar to Amazon’s.

Note: Consideration of the adjusted ratios is not to suggest that these losses are irrelevant.
WMT’s equity investments are an important part of its ecommerce strategy. GAAP now requires
the recognition of changes in fair value of such equity investments within earnings. Fluctuations
in WMT’s future earnings from changes in the value of investments are likely. And similarly,

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divestitures of underperforming businesses are part of WMT’s ongoing transformation.

Amazon does not have large unusual items in 2018 for which adjustments are needed.

Financial income
Because the numerator of the profit margin is defined as Net Income + Interest exp (after-tax),
it includes all sources of income (or losses), some of which are not related to the core business
of generating sales such as interest income, and equity in the income of unconsolidated affiliates.
This can distort the interpretation of the profit margin as a measure of the profitability of sales.
These items are small for both companies in 2018.

Effective Tax Rates

Using the information in the tax reconciliation table of the tax note of each company (see Note
9 for both companies), the effective tax rates in 2018 were:

Amazon: 10.6% (1,197 ÷ 11,261)

WMT: 37.4% (4,281 ÷ 11,460)

Hence, Amazon’s relatively low effective tax rate in 2018 contributed to its higher profit margin.
The two main items reducing Amazon’s effective tax rate are tax credits (associated with R&D-
like activities) and excess tax benefits associated with stock-based compensation (the tax
deductions related to stock-based compensation were higher than the GAAP-basis expenses
because Amazon’s stock price performed much better than expected).

In contrast to Amazon’s effective tax rate which was below the U.S. Federal statutory rate of
21%, WMT’s effective tax rate was elevated in 2018 relative to the Federal statutory tax rate
because of unusual items that reduced pre-tax income on the income statement without a
comparable reduction in taxable income. Hence, WMT’s effective tax rate in future years is
likely to be closer to 21%, reducing the gap between the effective tax rates of Amazon vs. WMT.

We do not have time in this class to discuss tax issues extensively, but this case illustrates that
they can make a substantial difference.

Total Asset Turnover Analysis

One way to gauge how efficiently a firm is using its assets is by measuring asset turnover. Broadly
speaking, asset turnover measures how many dollars of annual sales a firm is able to extract from
each dollar of assets. The total asset turnover (annual sales divided by average total assets) of
Amazon of 1.6 is lower than the total asset turnover of WMT of 2.4. The simple comparison of
the total asset turnover of the two companies suggests a relatively high efficiency with which
Walmart’s assets are managed. However, both Amazon and WMT are keenly focused on
operational efficiency.

To get insight into the differences in the total asset turnovers of Amazon and Walmart, let’s
consider the following issues:
• Mix of businesses
• Composition of assets:

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o Financial assets
o Goodwill and intangible assets
o Depreciated PPE (and finite-lived intangibles)
o Off-balance sheet leases (prior to 2019)
• Timing of acquisitions

Read the discussion of these issues and then answer the questions below.

Mix of businesses
Asset turnover varies a lot across industries—some industries are very asset intensive (e.g.,
utilities), whereas others are relatively asset-light (e.g., groceries). As we saw in the Profit
Margin Analysis, Amazon and Walmart are actually a blend of different businesses, and
therefore when comparing across these two companies it is instructive to consider the total asset
turnovers of Amazon’s and WMT’s individual business segments. Therefore, we return to the
segment disclosures in the companies’ footnotes. I used this information to calculate total asset
turnovers for each of the business segments in the tables below (make sure you see how I
calculated these figures):

Amazon

Walmar

It is interesting to note that Amazon’s asset utilization in its North American operations (which
primarily consists of retail sales of consumer products) is very similar to WMT’s US operations.
However, it should also be noted that the asset turnovers for Amazon’s segments do not include
Goodwill and intangible assets in the denominators. The lion’s share of Amazon’s goodwill is
associated with its North American business (Why? What is this related to?).

The table above suggests that one potentially large difference between Amazon and Walmart is
driven by AWS—this segment is a very capital intensive business with a relatively low asset
turnover, reducing the consolidated Total Asset Turnover of Amazon relative to WMT.
Amazon’s international segment has the highest asset turnover of its three segments, and exceeds
the asset turnover of WMT’s primarily brick & mortar retail business.

Composition of Assets
Differences in the composition of assets between companies can contribute to differences in their

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TAT. A common size balance sheet, which expresses each account as a percentage of total assets,
is one potentially useful tool to examine the make-up a firm’s set of assets. See the common size
balance sheets in the spreadsheet accompanying this case, review the discussion below, and then
answer the questions.

Several differences between the mix of assets on Amazon and WMT’s common size balance
sheets are worth noting. First, as is typical of high-tech, growth companies, Amazon holds a
relatively large amount of cash and marketable securities. Because these are non-productive
assets, this dampens its Total Asset Turnover relative to WMT. Second, Amazon has a relatively
high accounts receivable. Why is that? What is one type of business (business segment) that
Amazon has that WMT does not really have? Third, WMT has relatively high inventory and
relatively high PPE, compared to Amazon. Is this consistent with your expectations? Does this
reflect WMT’s enormous network of brick & mortar stores? The PPE of both companies is
depreciated to a similar degree (accumulated depreciation / gross PPE). Both companies have
considerable goodwill.

Financial assets (unrelated to sales)

A large portion of assets not associated with the generation of sales such as excess cash,
marketable securities, long-term investments in debt securities, lowers the total asset turnover
(all else equal).

Goodwill and intangible assets

Substantial goodwill and intangible assets on the balance sheet from prior acquisition activity
reduce the total asset turnover. Differences in acquisition intensity can therefore distort
comparisons of total asset turnover. The relative importance of goodwill and intangible assets in
Amazon’s asset mix is similar to WMT. If you were comparing the total asset turnover of two
otherwise comparable firms, you can assess the total asset turnover with and without the
goodwill and intangibles included in the denominator.

Aging of PPE (and finite-lived intangibles)

Writing off assets over time through depreciation and amortization increases the total asset
turnover, all else equal. Comparing the accumulated depreciation and amortization balances with
the gross book values indicates how fully written off such assets are.

It is interesting to note that WMT uses gross book values of PPE and intangible in the calculation
of its ROI, and adds back depreciation and amortization expenses to the income figure in the
numerator to mitigate distortions associated with this accounting effect (i.e. distortion).

Timing of Acquisitions
The timing of significant acquisitions within a year can distort any ratio such as the total asset
turnover which relies on both an income statement item (e.g. sales, profits, cost of goods sold)
and a balance sheet item (e.g., total assets, A/R, inventory, PPE). The reason is that the ratio
includes items from the acquired firm’s income statement for the portion of the year after the
acquisition only (i.e. sales in the case of the total asset turnover). However, since ratios average
the beginning and end of year balance sheet figures, the ratio treats the acquired firm’s assets as
if they were acquired mid-year. Hence if an acquisition occurs early in the (fiscal) year, the total

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asset turnover is overstated, and if it occurs late in the (fiscal) year the total asset turnover is
understated. To reduce distortions in ratios that are based on items from both income statements
and balance sheet, balance sheet amounts can be averaged across the most recent 4 quarters
(using quarterly balance sheets from 10-Q filings) instead of averaging the beginning and end of
year amounts.

Questions:
Use the profitability analysis spreadsheet along with the discussion above and information from
the 10-K documents as needed to provide very brief answers to the questions below (most
responses require only one or two sentences – bullet points work well). In addition to total asset
turnover, the questions also consider additional measures focused on the efficiency with which
specific operating assets (PPE, inventory, accounts receivable) and operating liabilities (accounts
payable) are managed.

17. Compare the Accounts receivable turnover and collection periods of Amazon and WMT in the
most recent year. How are these measures interpreted? What additional sales-related
information would enable more meaningful measures? What business line(s) do you think the
A/R are primarily related to for Amazon?

18. Compare the inventory turnover and holding period (also called “Days in Inventory”) of
Amazon and WMT in the most recent year. How are these measures interpreted? Is the relative
similarity of these measures surprising to you?

19. Both Amazon and WMT have seasonal businesses, with demand elevated in the 4th quarter.
How can seasonality distort the estimated inventory turnover and holding period? How could
you adjust for such seasonality? Also, what is the fiscal year end month of the two companies?
How does this difference potentially affect the fiscal year-end balance of inventory
considerations?

20. Compare the fixed asset turnovers of the two companies. How is the fixed asset turnover
interpreted? How do you expect the requirement to report operating leases on the balance
sheet beginning in 2019 to affect the fixed asset turnover of Amazon? Do you expect such a
large effect on the fixed asset turnover of WMT? Explain.

21. If Amazon continues to invest in AWS and AWS continues to become a larger portion of
Amazon’s sales, how would you expect Amazon’s total asset turnover to change over time?

22. Note that total asset turnover uses sales as the “flow” account, while inventory turnover and
accounts payable turnover uses cost of goods sold. Why do you think these ratios use different
flows in their calculations? Related, does AWS have inventory? Does AWS have COGS?

ADVANCED DUPONT ANALYSIS

While the Basic DuPont analysis provides useful insights, the Advanced DuPont approach offers
three advantages. 1) It better isolates the profitability effects of the firm’s operating vs. financing

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activities; 2) It gives firms “credit” for operating liability leverage (e.g., the extent to which a
company relies on suppliers for financing); 3) It frames the financial statements and results in a
way which is much more conducive to forecasting and cash flow analysis.

Allocating financial statement line items to operating and financing activities

While the Advanced approach has benefits, it also requires an extra step. We must first reclassify
the standard income statement and balance sheets by separating operating activities from financing
activities. We can then compute and interpret new ratios based on these classifications and consider
incremental insights over the traditional approach. Open the Amazon Profitability Analysis
spreadsheet for this case and look at the balance sheet and income statement tabs for Amazon and
Walmart. To make this process more efficient for you, you will note that I have allocated each line
item of the financial statements into either an operating activity or a financing activity. Only one
line item – provision for income taxes – is split between both operating and financing.

Even though I have already done this for you, I still expect you to be able to allocate financial
statements between operating and financing. Pages 107-112 of the textbook provide additional
discussion for how to do this. Generally, though, allocating activity between operating and
financing is relatively straightforward. I recommend starting with the balance sheet. Financing
activities are all the ways the company gets external financing from capital markets (e.g., debt and
equity). Note that this includes short-term financing (e.g., line of credit and current portion of long-
term debt) and long-term financing (e.g., long-term debt). Capital leases are also a form of external
financing, so these liabilities should be allocated to financing. Also, to make things easier, include
noncontrolling interests as financing items. Some assets are also considered financing activities.
This typically includes cash and marketable securities (you should start thinking of these accounts
as “negative debt”). 3 Any remaining assets and liabilities are treated as operating items. Note that
often companies have line items denoted as “other.” Footnotes to the financial statements typically
provide details about these line items and you can use this information to allocate them between
operating and financing. For ease, assume all “other” accounts for Walmart are operating.

After allocating the balance sheet, go to the income statement and place into financing activities
those items that are associated with the balance sheet items you moved into financing. The most
common financing items are interest expense, interest income, and net income attributable to
noncontrolling interests. The only slightly complicated income statement item is taxes. We allocate
part of this line item to operating and part to financing. To ease the calculations, simply use the
average effective tax rate for both operating and financing line items. 4 Note that because most
firms have more interest expense than interest income, the taxes for financing activities are usually
negative and the taxes for operating activities are usually larger than the total company tax
expense—and the total financing plus operating tax expense equals the total tax expense for the
company.

3
For the sake of ease, we often assume 100% of cash and marketable securities are considered “financing” but
technically this is not correct. Companies require some level of cash to operate. As a rule of thumb, this operating
cash is assumed to be 1% to 2% of revenues. Because this amount is generally not enough to change our analyses,
assuming all cash is financing related is usually fine.
4
To make your analysis more technically correct, you could assume different tax rates for operating and financing
activities. Because we do not dive deeply into taxes in this class, we will forego this complication.

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Calculating Advanced DuPont ratios

After allocating the balance sheet and income statement line items between operating and
financing activities, you are able to calculate the various Advanced DuPont ratios. Go to the
Advanced Framework tabs in the spreadsheet. First, note that ROCE at the top of the flow charts
is identical to the Basic DuPont calculations. While ROCE is the same, how we decompose it is
different. I have completed Amazon’s 2017 and 2018 calculations as well as Walmart’s 2017
calculations. You need to complete Walmart’s 2018 calculations (cells highlighted in yellow).

Analyzing the Advanced DuPont ratios

After completing the Advanced Framework spreadsheet for Walmart, all cells on the “Profitability
Analysis Summary” tab should be complete. Use this information to answer the questions below.

23. ROCE of Amazon in 2018 of 28.3% is considerably higher than the ROCE of Walmart of 8.9%.
Is this due to higher ROIC, higher effect of financial leverage, or both?

24. Although Amazon’s traditional ROA is lower than Walmart’s ROA in 2016 and 2017,
Amazon’s ROIC is higher than Walmart’s in all three years. What distinctive feature of
Amazon’s business model explains the difference in rankings for ROA vs. ROIC in 2016 and
2017?

25. Although the traditional Total Asset Turnover for Amazon is lower than that of Walmart in all
three years, Amazon’s Net Operating Asset Turnover is higher than Walmart’s in all years.
What distinctive feature of Amazon’s business model explains the difference in rankings?

26. Is Amazon’s higher ROIC in 2018 relative to Walmart due to higher ROOA, higher effect of
Operating Liability Leverage, or both?

The Advanced Decomposition also allows you to partition ROCE into three additive components,
which I summarize in the table below. See the “Profitability Analysis Summary” tab for the
calculations of these figures. We will discuss this in class.

Amazon
ROCE = ROOA + Effect of Operating Liab Lev + Effect of Fin Leverage
2017 12.9% = 4.6% + 7.6% + 0.7%
2018 28.3% = 10.0% + 12.5% + 5.8%

∆2018 15.4% = 5.4% + 4.9% + 5.1%

Walmart
ROCE = ROOA + Effect of Operating Liab Lev + Effect of Fin Leverage
2017 12.7% = 7.3% + 4.4% + 1.0%
2018 8.9% = 4.5% + 2.6% + 1.8%

∆2018 -3.8% = -2.8% + -1.8% + 0.8%

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