From the course: Financial Modeling and Forecasting Financial Statements

Home Depot 1985: Three weeks to live

From the course: Financial Modeling and Forecasting Financial Statements

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Home Depot 1985: Three weeks to live

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- In the 2018 Fortune 500 listing of the largest companies in the United States, Home Depot is number 23. 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 Harvard professor Krisha Palepu. - An analysis of Home Depot's financial statement numbers 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 per month. This is the amount of case paid to suppliers, to employees, and for other operating expenses that were in excess of the cash collected by customers. Four million dollars a month. - And there's additional bad cash flow news. During 1985, Home Depot also burned through an 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 burnt through capital spending, and four million dollars burned through daily operations. - Startup companies often keep track of their cash burn rate. A startup 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 startup company is to start generating cash from profitable business operations before burning through all 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. - [Pink Shirt Man] Now, 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 money 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 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 a 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. - Okay, we're all on the edge of our seats. What did they do? - Not so fast! We first need some background in financial modeling and financial statement forecasting before we are ready to appreciate the beauty of what the managers of Home Depot did back in 1985 to save the company.

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