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Module 4 Assignment: Financial Analysis Using the 2023 Annual Report

Nneoma .A. Edebeatu

Masters of Business Administration

ACC 6050: Accounting and Financial Reporting

Nexford University

Dr. Damian Dunbar

October 19, 2024

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Financial Statement Review

Based on the Home Depot's 2023 Annual Report, this is an overview of the three main financial statements
and the key components:

Income Statement (Consolidated Statements of Earnings)

Key Components:

 Net Sales: It is the total revenue from all forms of products/services sold.

 Cost of Goods Sold (COGS): The costs which are incurred directly in the production of goods in use
for a particular period.

 Gross Profit: The difference between net sales and cost of goods sold commonly abbreviated as
COGS.

 Operating Expenses: This comprises the cost of sales, selling general and administrative expenses.

 Operating Income: Gross profit less operating expenses.

 Net Earnings: Profit after all the cost of production or acquisition, taxes, and other interest charges.

Year on year changes:

 Net Sales: Down from $157,403 million in year 2022 to $152,669 million in year 2023, thus it can
be deduced that revenue has reduced slightly by 3.01%.

 Cost of Sales: Down from $104,625 million in year 2022 to $101,709 million in year 2023, thus it
can be deduced that cost of goods sold has reduced by 2.79%.

 Gross Profit: Down from $52,778 million in 2022 to $50,960 million in 2023, thus it can be deduced
that profitability has reduced by 3.44%.

 Operating Expenses: Up from $28,739 million in 2022 to $29,271 million in 2023, showing a rise in
the cost of operations despite lower sales by 1.85%.

 Operating Income: Down from $24,039 million in 2022 to $21,689 million in 2023, showing
reduced operational efficiency by 9.78%.

 Net Earnings: Down from $17,105 million to $15,143 million, showing reduced overall profitability
by 11.47%.
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Implications:

 It is seen that the year-on-year changes in the figures shows that Home Depot is undergoing through
a financial pressure where the company’s sales and profitability are in decline while operating
expenses are on the rise. Consequently, even though various cost reductions in COGS had partially
offset the losses, decreased income and poor profitability levels show that the firm needs to solve the
problem of falling sales and increased expenses. If no changes are made at the strategic level, such
trends can have a negative impact on the further evolution of competitiveness and business
development.

Balance Sheet (Consolidated Balance Sheets)

Key Components:

 Total Assets: Stands for everything to which the company has ownership rights (for instance, cash,
inventory, property, etc.).
 Total Liabilities: Stands for what belongs to the company as owing to others (for example, debts, and
accounts payable).
 Shareholders' Equity: The amount that remains after the company’s liability has been subtracted from
its total assets.

Year on year changes:

 Total Assets: It rose from $76,445 million in 2023 to $76,530 million in 2024 increasing by 0.11%.
This implies that the company was able to obtain slightly more resources needed during the year.
 Total Liabilities: It rose from 74,883 million in 2023 to 75,486 million in 2024 increasing by 0.80%.
This means that the company very likely incurred more debt or other liabilities during that period.
 Total Stockholders' Equity: It reduced from 1,562 million in 2023 to 1,044 million in 2024
indicating a total reduction of 33.18%. This could be due to a decline in retained earnings possibly as
a result of low profit or low loss making during the year

Implications:
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The current financial health of Home Depot looks even poorer in comparison with the situation detected in the
previous year. With liabilities increasing relative to stockholder’s equity this tells us that the company has
increased its level of financial risk.

Statement of Cash Flows (Consolidated Statements of Cash Flows)

Key Components:

 Operating Activities: Cash flows directly from the organization's main activities.

 Investing Activities: Cash flows from the buying or selling of an asset (for instance property and
investment).

 Financing Activities: Cash flows that come from debt and equity (for instance borrowing, dividends)
Year on year changes:

 Cash from Operating Activities: From 2022 to 2023 it has increased from $14,615 million to $21,172
million with a growth of 44.85% which shows improved cash generation from the company’s operational
activities.

 Cash from Investing Activities: From 2022 to 2023 it has increased from $3,140 million to $4,729
million with a growth of 50.65% indicating probably more investments, particularly on long term assets.

 Cash from Financing Activities: From 2022 to 2023 it has increased from $10,993 million to $15,443
million with a growth of 40.51% showing the company’s ability to make higher debt repayments or
larger distribution to the shareholders.

 Change in Cash and Cash Equivalents: From 2022 to 2023 it has increased from $482 million to $1
billion with a growth of 107.47%, due to a significantly enhanced liquidity position at the company even
though its profits have recently been dwindling.

Implications:
The improvement in cash flow from operations shows that the generation of cash from the core business of the
company remains sound though profits are down. The increase of investing and financing outflows can be due to
more strategic long-term investments or higher dividends to the debt or shareholders.

Overall, Home Depot's financial performance and position indicate:

The overall assets and cash flow in the company’s financial statements seem more or less healthy, but the profit
outlook continues to worsen as the net earnings and operating income decline. This is actually an alarming sign
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because while the company’s sales have been decreasing, the operating expenses have ventured upwards, which
may suggest problems with cost controls or resource productivity. The cash flow though is strong enough
indicating that the company is still financially healthy and can curb the decline in earnings through either
improved cost management or exploitation of existing revenue generating opportunities.

Transaction Analysis
Key Transactions and Journal Entries:

1. Purchase of Inventory:

Transaction: The Home Depot purchases inventory on credit for $20,896.

Journal Entry:

Inventory (Asset) Dr. $20,896

Accounts Payable (Liability) Cr. $20,896

Financial Impact: This transaction also creates two effects; it increases the assets (inventory) while at the

same time increasing the liabilities (accounts payable). The company's operational activities are supported

by increasing inventory for future sales. It shows the acquisition of goods on credit in which liquidity and

short-term obligations are affected.

2. Sale of Inventory:

Transaction: The Home Depot sells inventory for cash, with a cost of $4,512 and a selling price of $8,000.

Journal Entry:

Cash (Asset) Dr. $ 7,155 (after subtracting any possible discount or fees)

Sales Revenue (Income) Cr. $7,155

Cost of Goods Sold (Expense) Dr. $4,512

Financial Impact: This transaction raises the assets (cash) and equity (retained earnings), also raising total

expenses (cost of goods sold). The sale increases operational revenue and helps the company to optimize its
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revenue generation from inventory assets.

3. Payment of Accounts Payable:

Transaction: The Home Depot pays off its outstanding accounts payable of $4,536.

Journal Entry:

Accounts Payable (Liability) Dr. $4,536

Cash (Asset) Cr. $4,536

Financial Impact: It reduces the accounts payable as the liability (accounts payable) and the asset (cash). It

affects liquidity since it indicates a company’s management attempting to meet short term obligations.

4. Purchase of Property and Equipment:

Transaction: The Home Depot purchases a new building for $500,000.

Journal Entry:

Property and Equipment (Asset) Dr. $500,000

Cash (Asset) Cr. $500,000

Financial Impact: Financial Impact: It makes the long term assets (property and equipment) go up and the

current assets (cash) comes down. It indicates a strategic investment in fixed assets, may be on account of

expansion or continuity of operation facilities.

Ratio Analysis

Here are five key financial ratios to analyze the company’s financial health:

 Liquidity Ratios

1. Current Ratio: Current Assets / Current Liabilities

2024: 3,760 / 10,037 = 0.37

2023: 3,328 / 10,096 = 0.33

Interpretation: The current ratio improved slightly, but it remains below 1, meaning the company might

struggle to meet its short-term debt obligations, indicating liquidity risk.

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2. Quick Ratio: (Current Assets - Inventory) / Current Liabilities

2024: (3,760 - 20,976) / 10,037 = -1.71

2023: (3,328 - 24,866) / 10,096 = -2.14

Interpretation: Both years show negative quick ratios, raising significant liquidity concerns. This means

that even if the company sells all its current non-inventory assets, it will still not cover its current liabilities.

 Solvency Ratios

3. Debt-to-Equity Ratio: Total Liabilities / Total Equity

2024: 42,074 / 33,926 = 1.24

2023: 41,962 / 33,590 = 1.25

Interpretation: There is a marginal improvement in solvency, as revealed by the slight decline of the debt-

to-equity ratio. Even so, the figure remains greater than one, meaning that the company leans heavily

towards the use of debt as a source of funding – dangerous should the profit deteriorate further for the

company.

 Profitability Ratios

4. Return on Assets (ROA): Net Income / Total Assets

2024: 15,143 / 76,530 = 0.198 or 19.8%

2023: 17,105 / 76,445 = 0.223 or 22.3%

Interpretation: The ROA reduced which is a signal that the company is no longer efficient in converting

the assets to profit. This implies that the operational efficiency of the company is gradually declining.

5. Return on Equity (ROE): Net Income / Total Equity

2024: 15,143 / 33,926 = 0.446 or 44.6%

2023: 17,105 / 33,590 = 0.509 or 50.9%

Interpretation: The decrease in the ROE can be indicative of the fact that the company is actually growing

less efficient at creating value for shareholders. The decline may worry investors, especially considering the

falling equity base.

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6. Debt-to-Assets Ratio: Total Liabilities / Total Assets

2024: 75,486 / 76,530 = 0.986 or 98.6%

2023: 74,883 / 76,445 = 0.979 or 97.9%

Interpretation: This ratio has a slightly improved position, indicating that the liabilities have a very high

proportion of the company’s assets. This shows that it is a highly leveraged company – which could prove

problematic if its levels of profitability are to deteriorate further.

STRATEGIC RECOMMENDATION

Some strategic recommendations following the financial analysis can be recommended for The Home Depot

in order to enhance its financial condition and leverage on its advantages.

1. Improve Liquidity

Issue: Liquidity ratios, especially the current ratio (0.37 in 2024) and the quick ratio (-1.71 in 2024) are

relatively low and are below the ideal level. This suggests that the company may be in a position not to be

able to meet its short term obligations

Recommendation:

 Increase Cash Reserves: Cash flow management strategies should be implemented by the company;

the company should avoid large capital expenditures and aim at reducing collection periods from

customers (Linker, 2024).

 Optimize Inventory Levels: Due to the large proportion of inventory in current assets, it is prudent

for the company to enhance the inventory turnover in order to obtain cash. Introduction of JIT

inventory method or improving demand forecasting practices could alleviate overstock problem and

cut down carrying costs in turn.

 Renegotiate Payment Terms: Home Depot can try to negotiate better payment terms for extended

date with the suppliers so as to overcome its liabilities while managing the cash flow better.

2. Reduce Reliance on Debt:

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Issue: The debt to equity ratio of 1.24 which means that the company is in a highly leveraged position and

the debt to assets ratio of 98.6% means that virtually all the company assets are funded through debt. This

high debt reliance is regarded as a risk , bearing in mind the interest obligations, and finance flexibility.

Recommendation:

 Debt Reduction Strategy: The Home Depot should continue to decrease the amount of debts by

applying the excess of operating cash flows to pay for loans or through refinancing those debts in an

effort to achieve reduction of interest rates. Paying down interest-bearing debts will lead to freeing of

funds for reinvestment and enhance the company’s solvency.

 Equity Financing: In order to improve the proportion of capital structure, it has become possible of

the company to reduce the extent of debt financing and make the company financial position more

stable by raising capital through equity financing.

3. Enhance Profitability:

Issue: The return on assets (ROA) and return on equity (ROE) has reduced showing low profitability and

efficiency in mobilizing returns for the shareholders.

Recommendation:

 Operational Efficiency: The Company should look for ways to decrease operating costs since the

figures in 2023 grew by approximately 1.85%. Adopting cost-reduction strategies include

automating certain processes, improving the suppliers’ management and outsourcing unprofitable

activities (Linker, 2024).

 Increase Pricing Power: Due to the size of Home Depot it is possible for the company to use its

brand to extend to value added service which offer higher margins or even new products. Combined

with such pricing policies, this may increase sales margins without a substantial impact on quantity.

4. Invest in Growth Areas

Issue: Cash for investing activities have really increased and it shows that The Home Depot is expanding or

maybe investing in fixed assets, and this could exert pressure on liquidity.
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Recommendation:

 Strategic Capital Allocation: The Company should also aim to make high return investments,

which can be done by implementing digital transformation, improving the e-commerce platform, or

it could extend the geographical market. The investment should go through the assessment of

expectant returns from the investment and the growth impact that the investment will bring for the

long term (Linker, 2024).

 Digital & Supply Chain Innovation: The strategies that the Home Depot ought to employ include

the advancement of digitalization or more precisely the improvement of online purchasing because

customers are gradually moving to purchase their goods online. Also, the investments to build up

more supply chain efficiencies may help to reduce inventory costs while enhancing customer

services at the same time.

5. Increase Shareholders' Equity:

Issue: Retained earnings or possibly losses have reduced shareholders’ equity by 33.18% in 2024.

Recommendation:

 Retain Earnings: To strengthen equity, it would be wise for The Home Depot to retain more of its

earnings in order not to pay high dividends or engage in share buybacks at least in the near term. The

following approach will assist in constructing the financial insurance and boosting the equity base.

 Share Repurchase Strategy Review: The Company should therefore scrutinize whether the share

buyback options will be in most shareholders’ interest, especially during the time of declining

profits. Pausing the policies of share repurchases and paying attention to reinvestment could benefit

the company by keeping a comprehensive amount of equity achievable (Linker, 2024).

6. Build on Stability in Operation:

Issue: The Home Depot is, however, weakest in terms of Net Profit, however it demonstrates

operational capabilities as seen by a rise of 44.85% in cash generated from operations in the year

2023.
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Recommendation:

 Expand High-Margin Services: More installation and home improvement services are usually

offered at a better unit price since it has operational efficiency. Therefore, if services such as those

above are promoted then the company can do well in increasing its profit level.

 Supplier Negotiations: This big market share player in home improvement products should be

negotiating for more favorable prices on products from suppliers or longer payment terms, which

could add more solidity to cash flow (Linker, 2024).

Conclusion

For The Home Depot to have better financial performance, it needs to work on its liquidity, its debt

and operational performance. It should invest in high return projects, cut down on costs and creating

shareholders’ equity as security risks arise in the future. With all these measures, it shows that even

by maintaining and improving its operational efficiency while adapting the best Financial

Management principles it will be able to promote its growth while achieving sound financial health.

REFERENCES
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Adcock, K. (2016). Healthways: A Financial Analysis and Recommendations. EGrove.

https://egrove.olemiss.edu/hon_thesis/511/

Decker, T. (2024). ’23 Annual Report.

https://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/2024/2023%20Annual%20Report%20-

%20Combined.pdf

Linker, E. (2024, March 28). A Step-by-Step Guide to Effective Financial Analysis. Improvado.io.

https://improvado.io/blog/financial-data-analysis

Nora, M. P. C. (2020). Equity valuation: the Home Depot, Inc. Repositorio.ucp.pt, 65(246).

https://repositorio.ucp.pt/handle/10400.14/31323