“Our ultimate financial measure, and the one we most want to drive over the long-term, is free cash flow per share.
Why not focus first and foremost, as many do, on earnings, earnings per share or earnings growth? The simple answer is that earnings don’t directly translate into cash flows, and shares are worth only the present value of their future cash flows, not the present value of their future earnings.”
Prioritizing free cash flow will allow you to experiment and innovate quickly, as capital won’t be tied up in investments that could be irrelevant by the time they’re paid off. In today’s fast-moving business environment, this is essential to keep from falling behind.
Many public companies prioritize metrics like earnings per share or earnings growth when benchmarking their performance. Media coverage, analyst reports, and public opinion all play a role in developing this focus, but it can be ultimately counterproductive for a large enterprise to concentrate on increasing its earnings, even when its primary obligation is to its shareholders.
As Bezos reminds us, “Earnings don’t directly translate into cash flows, and shares are worth only the present value of their future cash flows.”
The solution to building a financially durable and growth-ready company is to focus less on earnings, and more on free cash flow.
If you build a business with earnings growth but no free cash flow, it’s often a poor investment over the long term.
Structuring your business to prioritize free cash flow will look different from industry to industry, but Amazon does it in a few key ways:
- The company turns over inventory quickly
- It collects payments from customers before payments to suppliers are due
- It minimizes its investment in its own inventory
Amazon maintains a cash generative operating cycle and can keep its investments in fixed assets low, at only 4% of all sales in 2004. Looking forward from 2004 to 2018 you can see how free cash flow has accelerated with sales and ahead of profit, allowing amazon to invest in innovation.
Jeff Bezos letter to shareholders
Jeff Bezos has been writing a letter to shareholders since 1997 and looking at all if them gives an insight to the organisation and a masterclass in leadership. This is a series of short blogs that gives you a snap shot / key takes outs of each letter, along with links to them all.
link to all letters to shareholders
- 1997: Bring on shareholders who align with your values
- 1998: Stay terrified of your customers
- 1999: Build on top of infrastructure that’s improving on its own
- 2000: In lean times, build a cash moat
- 2001: Measure your company by your free cash flow
- 2002: Build your business on your fixed costs
- 2003: Long-term thinking is rooted in ownership
- 2004: Free cash flow enables more innovation
- 2005: Don’t get fixated on short-term numbers
- 2006: Nurture your seedlings to build big lines of business
- 2007: Missionaries build better products
- 2008: Work backwards from customer needs to know what to build next
- 2009: Focus on inputs — the outputs will take care of themselves
- 2010: R&D should pervade every department
- 2011: Self-service platforms unlock innovation
- 2012: Surprise and delight your customers to build long-term trust
- 2013: Decentralize decision-making to generate innovation
- 2014: Bet on ideas that have unlimited upside
- 2015: Don’t deliberate over easily reversible decisions
- 2016: Move fast and focus on outcomes
- 2017: Build high standards into company culture
- 2018: Wandering is an essential counterbalance to efficiency