Invent and Wander: The Collected Writings of Jeff Bezos

by Jeff Bezos

Earnings $10,000 $20,000 $40,000 $80,000 Depreciation 40,000 80,000 160,000 320,000 Working Capital — — — — Operational Cash Flow 50,000 100,000 200,000 400,000 Capital Expenditures 160,000 160,000 320,000 640,000 Free Cash Flow $(110,000) $ (60,000) $(120,000) $(240,000) There are of course other business models where earnings more closely approximate cash flows. But as our transportation example illustrates, one cannot assess the creation or destruction of shareholder value with certainty by looking at the income statement alone. Notice, too, that a focus on EBITDA (earnings before interest, taxes, depreciation, and amortization) would lead to the same faulty conclusion about the health of the business. Sequential annual EBITDA would have been $50, $100, $200 and $400 million—100 percent growth for three straight years. But without taking into account the $1.28 billion in capital expenditures necessary to generate this “cash flow,” we’re getting only part of the story—EBITDA isn’t cash flow. What if we modified the growth rates and, correspondingly, capital expenditures for machinery—would cash flows have deteriorated or improved? Year 2, 3, and 4 Sales and Earnings Growth Rate Number of Machines in Year 4 Year 1 to 4 Cumulative Earnings Year 1 to 4 Cumulative Free Cash Flow (in thousands) 0%, 0%, 0% 1 $ 40,000 $ 40,000 100%, 50%, 33% 4 $100,000 $(140,000) 100%, 100%, 100% 8 $150,000 $(530,000) Paradoxically, from a cash flow perspective,