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Home Depot Financial Statement Analysis Report

Jerod Brockelman

4/29/2014

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Home Depot Financial Statement Analysis Report

All companies need to compile financial information in such a fashion that it allows them to effectively evaluate and analyze the financial health and progress of the business. While it is important for the company to have this information for its own use, it is also helpful and essential to persons and businesses outside of the company. The information provided in the financial statements allows outside persons to effectively analyze and evaluate the overall health and progress of a business entity; for example, this information can be used by a lender to determine if a company is healthy enough to pay its debts. Investors may also use the information in the financial statements to determine if they might wish to make a financial investment in the company being evaluated. With these things in mind, the purpose of this report is to provide insight into the financial statements and accompanying notes of Home Depot, Inc.

PART I

Home depot, Inc. has provided four main comparative financial statements covering specific periods. The Consolidated Statement of Earnings which is meant to show the net income or loss of a business covers a three year period including fiscal year ended 2008, 2009 and 2010. The Consolidated Statement of Stockholders Equity and Comprehensive Income covers several years. It begins with the balance as of January 28, 2007 and shows the changes as of Feb. 3, 2008, Feb. 1, 2009, and gives the final balance as of Jan. 31, 2010. Home Depot also has provided a Balance Sheet listing all of its Assets, Liabilities and Owners Equity. The Balance sheet provided covers the balances for a two year period including February 1, 2009 and January 31, 2010. The fourth main statement provided is the Statement of Cash Flows. It covers the fiscal year ended for February 3, 2008, February 1, 2009 and January 31, 2010.

An important feature of all public financial documents is their accuracy. To safeguard against mistakes and/or false and misleading financial statements many businesses are required to obtain outside financial auditors to examine and verify that the information provided in the financial statements is accurate, and that it follows the guidelines of Generally Accepted Accounting Principles (GAAP). Home Depot, Inc. has employed the services of the outside accounting firm KPMG LLP. According to the Report of Independent Registered Public Accounting Firm provided with Home Depot’s statements, KPMG has determined that it is their opinion that Home Depot’s financial statements are fair and accurate and are in conformity with GAAP.

As an investor and owner in a business it is important to know the amount of Retained Earnings, in other words, the amount of money left over for its owners. This amount would be reflected in a company’s Statement of Retained Earnings. Home Depot combines its retained earnings with other relevant financial information in a statement called the Consolidated Statements of Stockholders Equity and Comprehensive Income. Details about the changes in retained earnings can be found in this statement.

As an investor and creditor it is important to know how much cash a business is generating, and from which activities the cash flow is coming from. The Statement of Cash Flows provides us with the information we need to effectively evaluate the cash flow from three specific areas of a business, including operating activities, investing activities, and financing activities. By using the Statement of Cash

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Flows we are able to analyze from one period to the next the increases and decreases in cash flow from the different activities. This allows us not only to evaluate performance in the different areas, but also to determine a company’s debt paying abilities. Upon reviewing the Statement of Cash flows for Home Depot, Inc. the cash flows from the different activities is as follows:

 

January 31, 2010

February 1, 2009

February 3, 2008

From Operating Activities:

5,125,000,000

5,528,000,000

5,727,000,000

From Investing Activities:

(755,000,000)

(1,729,000,000)

4,758,000,000

From Financing Activities:

(3,503,000,000)

(3,680,000,000)

(10,639,000,000)

Total increase/decrease:

867,000,000

119,000,000

(154,000,000)

End of year totals:

1,421,000,000

519,000,000

445,000,000

As you can see from observing the cash balances above, cash flow from operating activities has been positive in each of the three years listed; however, it is worth mentioning that cash provided by operating activities has been decreasing each year sense 2008.

The investing activities section shows us that in 2008 Home Depot received approximately $4.8 billion from investing; however, in 2009 and 2010 Home Depot invested heavily, mainly on capital expenditures, significantly eliminating any positive cash flows from investing for those two years. The pace at which Home Depot used cash in investing did significantly decline however in 2010.

By observing the financing activities section we see that Home Depot used large amounts of cash for its financing activities. The majority of the cash used in 2010 was for the repurchase of common stock as well as dividends paid to stockholders. In 2009 significantly less cash was used in financing activities with repayments of short and long term debt as well as payments of dividends being the biggest uses of cash. 2010 saw a slight decrease in cash used from the previous year with repayments of long term debt and payment of dividends again being the biggest uses of cash.

Upon final observation one can see that cash and cash equivalents at the end of each year was positive; however, this calculation takes into account cash and cash equivalent balances at the beginning of the year as well as the effects of exchange rates. If the beginning balances and exchange rate differences were stripped away we would see that cash and cash equivalents decreased during 2008 by $154,000,000, increased by $119,000,000 during 2009, and then significantly increased by $867,000,000 during 2010.

PART II

When a lender is considering making loans to a business there are certain criteria that the lender must evaluate before committing to providing funds to the business. In the event that the business is looking for short term financing the lender would want to consider the business’s ability to earn enough revenue to pay its bills as they come due, in addition to many other factors. Some ways we can

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determine the business’s ability to pay its short term debt is by evaluating its current ratio, quick ratio, working capital, and the percentages by which the company’s working capital and cash & cash equivalents have changed from the previous years. Listed below are some key metrics that will be used to evaluate the short term debt paying ability for Home Depot, Inc.

January 31, 2010

February 1, 2009

Current Ratio

1.3:1

1.2:1

Quick Ratio

0.2:1

0.1:1

Working Capital

$3,537,000,000

$2,209,000,000

% change in working capital from prior year 60.1%

% change in cash & cash equivalents from prior year 173.8%

By using the information above we can now determine the ability of Home Depot to pay its short term debts. Starting with the current ratio it is obvious that the amount of current assets have increased at a faster rate than current liabilities, as a matter of fact this ratio has improved by about 8.3%. Looking now at the quick ratio, we can get an even better perspective of just how easily Home Depot can pay its short term debts. The quick ratio, also known as the Acid Test Ratio, factors out current assets such as inventory that might take longer to liquidate, leaving only the most liquid assets including cash & cash equivalents, marketable securities, and receivables. You can see above that the quick ratio improved from 0.1:1 to 0.2:1. This represents a 100% improvement in this ratio from the prior year. The main driver of the improvement in the quick ratio was a significant increase of 173.3% in cash & cash equivalents. Finally, working capital, which represents how much current assets exceed current liabilities, has also improved by approximately $1.3 billion, representing a 60.1% increase over the prior year.

Aside from the ability of Home Depot to pay its debts there must be other considerations; for instance, one might want to know how much competition exists in the space. We would want to know if home Depot is gaining or losing market share. Is there any potential legislation that could hinder business growth? Is the economy growing or declining? These are but a few of many possible questions that a lender could ask themselves. A review of Home Depot’s previous credit ratings would certainly be something to consider also. As a lender we would also be interested in the accounts receivable turnover rate, inventory turnover rate, days to collect accounts receivable, number of days to sell average inventory, and cash flow. Each of these metrics gives us insight into how quickly assets can be converted into cash and therefore used to pay short term debts.

After a review of Home Depot, Inc. it is concluded that a credit rating of A-Outstanding should be issued to the company. This determination is made based on a thorough review of the company’s financial statements as well as its tremendous market presence in the U.S. and abroad. Home Depot has proven its ability to honor its obligations over many years, more specifically during the 2007 through 2010 period. This period (known as the great recession) was a very difficult time economically for the entire

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country, as well as overseas, especially for the housing industry and those businesses that served it. Home Depot’s strong brand allowed it to raise capital in the financial markets through issuance of common stock and borrowing. Through this difficult time Home depot continued to pay its shareholders dividends. Home Depot also took advantage of the decline in share price during this period to repurchase outstanding shares at historically low prices, creating value for the business and its shareholders as the markets recovered. A review of the ten year summary of operating results has shown that Home Depot has consistently grown earnings, assets, and owners’ equity while also consistently increasing cash flows over the periods with the exception of the 2007 to 2010 period; this period however appears to be an anomaly due to the severe economic downturn. Considering the severity of the recession Home depot has shown diligence in maintaining its key short term borrowing ratios in comparison with those of prior periods and has shown the ability to navigate through extremely difficult market conditions by increasing working capital and increasing its cash and cash equivalents significantly over the more recent period. For these reasons we conclude that Home Depot, Inc. deserves and shall be assigned the highest credit rating.

PART III

The following computations are key ratios to be used in the evaluation of profitability for Home Depot, Inc. for Fiscal years ending January 31, 2010 and February 1, 2009.

January 31, 2010

February 1, 2009

Percentage change in net sales (relative to prior year)

(7.2%)

(7.8%)

Percentage change in net earnings

17.74%

(48.6%)

Gross profit rate

33.9%

33.7%

Net income as a percentage of sales

4%

3.2%

Return on average total assets

11.7%

10.2%

Return on average total equity

14.3%

12.7%

By analyzing the above trends for Home Depot we can see that the company’s earnings are improving. When looking at the Percentage change in net sales we can see that, though net sales are still declining, they are declining at a slower pace than in the previous year. Considering this time frame was occurring on the tail end of a severe recession it should not be too much cause for concern that sales were still declining; in fact, the slower pace of the decline is cause for optimism. From the perspective of a shareholder the improvement in the percentage change in net earnings should be viewed as extremely positive as it reversed from an extreme decline in net income of nearly 50% in the prior year to growth of profits of nearly 18%. Based on the gross profit rate we are able to see that Home depot has been able to control its costs of goods sold, and has even been able to reduce costs of goods sold slightly. Home depot has managed to consistently improve this ratio in almost all of the last 10 years, which is especially impressive considering the week economic environment during this period. The net income as

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a percentage of sales figure should be viewed as extremely positive. Though it is still considerably lower than its ten year average of around 5.8%, it has increased by 80 basis points from 3.2% to 4% over the previous year. This is significant because it means that Home depot is making a higher profit per every one dollar of sales. It is a clear sign that the company is managing expenses effectively. We can also see clearly that Home Depot is utilizing the company assets efficiently as seen by the 150 basis point increase in return on average total assets. Finally we see that return on equity has increased by 160 basis points. This increase in return on equity is a clear indication of increasing profitability; it serves as an indication of how well company management utilizes the investments by stockholders. After a review of these key ratios it is clear that Home Depots’ earnings are improving by every metric listed above. It is a clear indication that a combination of excellent leadership, management and an improving economic environment has propelled Home Depot into growth mode once again, allowing it to increase wealth for its shareholders.