Join Jim Stice for an in-depth discussion in this video Home Depot 1985: Three weeks to live, part of Running a Profitable Business: Understanding Cash Flow.
- In the 2014 Fortune 500 listing of the largest companies in the United States, Home Depot is number 33. Home Depot is by far the dominant home-improvement retailer in the United States and in the world. - Most people don't know that Home Depot was close to death back in 1985. We know because for many years we've been teaching a Harvard business-school case about Home Depot. The case was written by Professor Krishna Palepu. - An analysis of Home Depot's financial statements from 1985 reveals that the company's income was down, but the income drop doesn't appear to be an immediate crisis.
- Not a crisis until you look at the cash flow numbers. During 1985 Home Depot's operations were burning through four-million dollars a month. This is the amount of cash paid to suppliers, to employees, and for other operating expenses that was in excess of the amount of cash collected from customers. Four-million dollars per month. - And there is additional bad cash-flow news. During 1985 Home Depot also burned through and average of eight-million dollars per month building new stores and buying some stores from other companies. - In total, Home Depot's 1985 cash-burn rate was 12 million dollars a month.
Eight-million dollars burned through capital spending and four-million dollars burned through daily operations. - Start-up companies often keep track of their cash-burn rate. A start-up company starts off with a pile of cash, cash from the personal savings of the founders, usually not much, cash from early investors, and maybe some cash from a local bank loan. - The goal of the start-up company is to start generating cash from profitable operations before burning through all of that initial pile of cash. - The size of that initial pile of cash combined with the cash-burn rate gives the company founders an idea of how long they can last before they have to go back out into the streets looking for additional financing.
- In Home Depot's case back in 1985 remember that the company was burning through cash at the rate of 12 million dollars a month. In 1985 the company had borrowed 92 million dollars. That was in addition to the 120 million dollars the company had borrowed the year before. Could Home Depot just keep borrowing cash forever? - Well when 1986 started Home Depot had a cash balance of nine-million dollars with a cash-burn rate of 12 million dollars per month. That left them with just three weeks of remaining cash. - Three weeks to come up with a cash-flow plan.
Three weeks with the cash burning away at three-million dollars per week, three weeks to arrange new loans or get additional cash from investors or three weeks to come up with a plan to slow down or even reverse this cash-burn rate. - So, what did they do? - Well not so fast. We need some background in cash-flow analysis first before we are ready to appreciate the beauty of what the managers of Home Depot did back in 1985 to save the company.
Want to hear more from Jim and Kay? Learn about all three types of accounting—financial, managerial, and income tax—in their Accounting Fundamentals course.
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- Differentiating between net income and operating cash flow
- Categorizing cash flow
- Using financial data to deduce cash flow
- Managing operating, investing, and financing cash flows
- Typical cash flow patterns
- Converting net income into operating cash flow
- Improving operating cash flow