Learn how to evaluate Home Depot's income statement.
- In the 2017 Fortune 500 listing of the largest companies in the United States, Home Depot's number 23. Home Depot is by far the dominant home improvement retailer in the United States and in the world. - What most people don't know is 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 statement numbers from 1985 reveals that the companies 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 per month. This is the amount of cash paid to suppliers, to employees, for other operating expenses. That was in excess of the amount of cash collected from customers by four million dollars a month. - [Man With Glasses] And there's an additional bad cash flow news here. During 1985, Home Depot was also burning through an average of eight million dollars per month, building new stores and buying some stores from other companies. - [Man On Right] In total, Home Depot's 1985 cash burn rate was 12 million dollars per month. Eight million dollars burned through capital spending, and four million dollars burned through daily operations. - 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 just three weeks of remaining cash. - Three weeks to come up with a cash flow plan. Three weeks with 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 could they do to address this cash flow crisis? - Well when we teach this case, we use a spreadsheet that contains a forecast of Home Depot's financial statements for the five years: 1986 through 1990. - [Man With Glasses] We use this forecast to explore the impact of various actions. What if they improve profitability? What if they manage inventory more efficiently? What if they slow their growth rate down? - [Man On Right] A set of forecasted financial statements allows you to try out various options on paper, before actually implementing them. - So, what did Home Depot do back in 1986? Well, the forecasted financial statements indicated that an improvement in inventory management would dramatically help Home Depot's cash flow situation. - Home Depot launched an inventory management system that allowed them to track their inventory more carefully. With more careful inventory management, they didn't need as much inventory lying around idle, in their warehouse stores. - Less inventory lying around means fewer inventory purchases and that means less cash flowing out to suppliers to pay for inventory that's going to be just sitting around on shelves. - [Man On Right] Business problems, such as Home Depot's 1985 cash flow problems, can be identified, analyzed, and solved, at least on paper, through the use of forecasted financial statements.
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