Home depot debt to equity ratio

Appendix A

MANAGERIAL ACCOUNTING

8e

Al L. HARTGRAVES Wayne J. MORSE

© Cambridge Business Publishers, 2018

2

Describe the importance of analyzing financial statements.

1

Learning Objective

Management’s Analysis

© Cambridge Business Publishers, 2018

3

Primary reason to analyze

Evaluate the overall performance of the firm

Especially as seen by those external to the firm

Should be aware of total company performance, in addition to each manager’s own responsibility area

Analysis helps managers understand

How the firm is performing, and

How the firm is perceived

© Cambridge Business Publishers, 2018

4

Evaluate factors that influence financial statements and their analysis.

2

Learning Objective

Factors Impacting Financial Statement Analysis

© Cambridge Business Publishers, 2018

5

Changes in product mix can distort a comparison of financial statements

Because individual products have unique profit margins and a change in mix influences the firm’s profit margin

Changes in organizational structure should be reviewed as part of financial analysis

Mergers and acquisitions

© Cambridge Business Publishers, 2018

6

Specify alternative standards useful in financial statement analysis. Perform vertical and horizontal analysis.

3

Learning Objective

Financial Analysis Standards

© Cambridge Business Publishers, 2018

7

Vertical analysis

Restatement of amounts in the current financial statements as a percentage of some base measure

Horizontal analysis

Comparison of a firm’s current financial measures to those of previous periods

Competitor analysis

Comparison of a firm’s financial measures to similar measures for other firms in the industry or to industry averages

Comparison of a firm’s financial measures to its budgeted measures

Beginning the Financial Analysis

© Cambridge Business Publishers, 2018

8

Vertical analysis

Conversion of all amounts to percentages of a base amount

Base amount on income statement is sales

Base amount on balance sheet is total assets

Common size statements

After all accounts of a particular statement are converted into percentages

Useful for

Detecting items that are out of line

Detecting deviations from preset amounts

Detecting other problems

Evaluating Against Comparable Measures

© Cambridge Business Publishers, 2018

9

Beneficial to managers to compare against other firms in the same industry

Financial information services publish averages for all major industries

Dun and Bradstreet

Standard & Poor’s

Moody’s

Awareness of differences between firms is necessary, such as

Geographical effects

Accounting practices

Other Measures

© Cambridge Business Publishers, 2018

10

Measures of solvency and performance

Should be compared to industry norms

Comparison of three successive periods is helpful

Determining averages for a period

Beginning amount + Ending amount

2

© Cambridge Business Publishers, 2018

11

Describe vertical and horizontal analysis, and their difference.

4

Learning Objective

Uses sales from the income statement and total assets from the balance sheet

Both set at 100%

Helps to identify

Significant changes that have taken place during the period, and

Determine whether the changes have favorable or unfavorable impacts on solvency and performance

Determine if the company’s operating goals are met

Vertical Analysis

© Cambridge Business Publishers, 2018

12

Common Size Income Statement

© Cambridge Business Publishers, 2018

13

Useful for analyzing changes over time

Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf

Common Size Balance Sheet Asset Section

© Cambridge Business Publishers, 2018

14

Useful for analyzing changes over time

Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf

Common Size Balance Sheet Liabilities & Stockholders’ Equity Section

© Cambridge Business Publishers, 2018

15

Useful for analyzing changes over time

Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf

Horizontal Analysis

© Cambridge Business Publishers, 2018

16

Used to evaluate trends in the financial condition of an organization

Allows current year common size statements to be compared

To those of prior years, and

To the organization’s goals and objectives

Calculate the % change from one year to the next, making sure to use the prior year as the base.

© Cambridge Business Publishers, 2018

17

Explain the analysis of a firm’s solvency.

4

Learning Objective

Solvency Analysis

© Cambridge Business Publishers, 2018

18

A firm’s ability to pay its debts as they come due

Primary measures

Short-term solvency

Current ratio

Working capital

Acid test ratio

Inventory turnover

Days sales in receivables

Long-term solvency

Debt-to-equity ratio

Times-interest-earned

Current Ratio

© Cambridge Business Publishers, 2018

19

Measures the relation between current assets and current liabilities

Indicates the extent to which current assets are available to cover current liabilities

Current assets

Current liabilities

Current ratio =

$16,993 million

$12,526 million

Current ratio for Home Depot =

= 1.36

Home Depot, Inc. has $1.36 of current assets for each $1 of current liabilities.

Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf

Working Capital

© Cambridge Business Publishers, 2018

20

The net amount of working funds available in the short run

Working Capital = Current assets – Current liabilities

Working capital for Home Depot =

$16,993 million – $12,526 million = $4,467 million

Home Depot, Inc. has $4,467 million available in the short-run for operations.

Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf

Acid Test (Quick) Ratio

© Cambridge Business Publishers, 2018

21

Measures the availability of assets that can be quickly converted into cash to pay current liabilities

Acid test ratio for Home Depot

$2,216 mil + $0 mil + $1,890 mil

$12,526 mil

= 0.328

=

Home Depot has about $0.33 of current monetary assets for each $1 of current liabilities.

Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf

Acid test

ratio

Cash +

Marketable

securities

+

Current accounts

receivable

Current liabilities

=

Inventory Turnover

© Cambridge Business Publishers, 2018

22

Measures the approximate number of times the average stock of inventory is sold and replenished during the year

Inventory turnover for Home Depot

$58,254 million

[($11,809 million + $11,079 million) / 2]

= 5.09

=

Cost of goods sold

Average inventory

Inventory turnover =

Home Depot’s average stock of inventory was sold and replenished about 5.09 times during the year.

Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf

Days Sales in Receivables

© Cambridge Business Publishers, 2018

23

Measures the number of days, on average, it takes to generate the credit sales uncollected at any point in time

Accounts receivable

Average daily credit sales

Days sales in

receivables

=

Home Depot takes approximately 16 days to convert its accounts receivable into cash.

Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf

Days sales in receivables for Home Depot

$1,890 million

[($88,519 million x 50%*) / 365]

=

*Estimated credit sales

= 15.59 days

Debt-to-Equity Ratio

© Cambridge Business Publishers, 2018

24

Measures the degree to which a company relies on debt versus equity financing

Total liabilities

Total stockholders’ equity

Debt-to-equity ratio

=

Debt-to-equity ratio for Home Depot

$36,233 million

$6,316 million

=

= 5.74

Home Depot’s debt-to-equity ratio indicates that its creditors have provided $5.74 of capital for each $1 that stockholders have provided.

Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf

Times-Interest-Earned

© Cambridge Business Publishers, 2018

25

Measures the adequacy of earnings to provide payment of interest charges

Times-interest-earned

=

Net

income

Interest

expense

+

Income

taxes

Interest expense

+

Times-interest-earned

for Home Depot

$7,009 mil + $919mil + $4,012 mil

$919 mil

12.99 times

=

=

Home Depot has approximately 13 times the earnings needed to cover its annual interest costs.

Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf

© Cambridge Business Publishers, 2018

26

Explain the analysis of a firm’s performance.

5

Learning Objective

Performance Analysis

© Cambridge Business Publishers, 2018

27

Basic activities of a typical for-profit organization

Generating capital—equity and debt

Acquiring assets with capital

Using assets to generate sales and profits

Using profits to pay the cost of capital

Primary measures of performance

Gross Margin

Asset turnover

Return on sales

Return on assets

Return on equity

Earnings per share

Asset Turnover

© Cambridge Business Publishers, 2018

28

Measures the firm’s ability to use its assets to generate sales

Asset

Turnover for

Home Depot

$88,519 million

[($42,549 million + $39,946 million) / 2]

= 2.15

=

Sales

Average total assets

Asset turnover =

Each $1 of Home Depot’s assets during the year generated $2.15 of sales.

Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf

Return on Sales

© Cambridge Business Publishers, 2018

29

Measures the ability to generate profits from sales produced by the firm’s assets

On average, 8.58% of each $1 of Home Depot’s sales remained as profit after covering all expenses other than interest.

Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf

Return on sales =

Net of tax

interest expense

Net income

Sales

+

*Effective tax rate from Home Depot’s annual report

Return on sales for Home Depot

$7,009 million + [$919 x (1 – 0.364*)]

$88,519 million

=

= 8.58%

Return on Assets

© Cambridge Business Publishers, 2018

30

Measures the firm’s ability to use its assets to generate profits

Combines asset turnover and return on sales

Return on assets =

Net of tax

interest expense

Net income

Average total assets

+

OR: Asset turnover x Return on sales

= 2.15 x 8.58% = 18.45%

*Effective tax rate from Home Depot’s annual report

Return on assets for Home Depot

$7,009 million + [$919 x (1 – 0.364*)]

[($42,549 million + $39,946 million) / 2]

=

= 18.41%

Source: http://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/documents/current-forms/hd-fy-2015-annual-report.pdf

Difference due to rounding

Return on Equity

© Cambridge Business Publishers, 2018

31

Measures the profits attributable to shareholders as a percentage of their equity in the firm

Return on equity =

Net income

Average stockholders’ equity

Return on equity for Home Depot

$7,009 million