Working Capital Strategies of Home Depot - Essay Example

Working Capital Strategies of Home Depot  Introduction: The company, which we are dealing with, belongs to the retail industry and its main productrange includes home improvements, materials for building, lawn and gardening products, accompanied by various services. The year 2008 showed a decline in the net sales of the company by almost 7.8 %. (Annual report Home Depot, 2008). According to the management the cause of this steep decline is not company specific, but rather it is being contributed by the downward trend of the entire economic environment, which has hit the retail industry hugely. As a result of this the core concentration of the company is now on improving its operations and to attain a better position in the industry by deploying suitable cash management strategies. This particular report will focus on the different asset-liability management strategies that the company has adapted so far. The report analyses the results of the year 2006, 2007 and 2008. It also makes an assessment about the future cash management strategies that the company can adapt.   Analysis of the outcome of 2006: The end of financial year 2006 showed a steady increase in the Net sales for the company. The increase was more than US $ 9 billion, when compared to the figures of the financial year 2005. (Annual report Home Depot, 2006).Side by side the company’s net asset also increased to US $ 52.3 billion from US $ 44.4 billion in this particular year. (Annual report Home Depot, 2006). This increase in current assets is mostly due to the acquisition of Hughes Supply in the supply segment. Also apart from this the company made another major acquisition in China, in its retail segments. Thus the supply chains were made stronger as well as there was a steady strategic decision, which increased the number of outlets in the developing market of China. Due to all these facts it can be concluded that though the net sales of the company increased by 11.4% but the Net earnings remained same to US $5.8 billion, when compared to the previous year. (Annual report Home Depot, 2006). In fact the net earning as a percentage of net sales showed a decreasing trend. The cause for this decline can be twofold. Firstly it may be due to the increase in fixed asset of the company that year (which incurred a huge amount of cost), and it may also be due to the lowering of demand of the household appliances. The later fact is also reflected in the company’s balance sheet where it shows that weighted average weekly sales per operating store as well as the retail comparable store, as a percentage of total sales have decreased to some extent. Also another fact that needs to be discussed is the variation in gross profit. Taking an overall view the gross profit for the company has increased by 9%, when compared to 2005, but the gross profit as a percentage of net sales has declined again. (Annual report Home Depot, 2006).This decline is also the cause of the increased complexities in the service segment of the company. Also there was an evident change in the business mix of the company. While analyzing the cash flow of the company from the operating activities it should be noted that the net cash flow is positive and it has increased from about US $ 6620 million to US $ 7661 million. (Annual report Home Depot, 2006).The major contributing element for this increase is the increase in accounts payable and accrued liabilities. This was almost certain as the company this year focused on expanding its operations both on the retail and supply segment. Side by side there is a steady increase in the cash flow of the other current asset segment as well. It should be kept in mind that the total assets of the company in this particular year have increased to a great extent. If we look into the composition of the assets of the company it is notable that 2006 has seen a decrease in cash and cash equivalents assets of the company. The receivable segment mostly contributes the increase in current assets and also by the merchandise inventories the company was holding. These may not be considered as very strong points as increase in debt components does not reflect positive health of the company. Assets in the form of land, buildings, furniture and other accessories have also increased significantly due to the increased number of outlets of the company. Significantly enough with better performances and with its expansion policies the goodwill of the company has also increased resulting in an over all increase in the assets of the company. (Annual report Home Depot, 2006). From these facts it can be deduced that the company in this particular year had focused less on retaining cash in hand but it has more concentrated on the expansion policies. The outlook of the company can be considered at this point to be positive, but also very aggressive as in the liabilities segment it has shown a steep increase in its Long-term debts. In the future the company needs to balance both of the aspects and slowly should concentrate on the extracting more profit from the expanded facilities they have. The company certainly needs to increase it liquidity in the next financial year to meet all the debt components. Next expansion plans can only be taken, when the components like sales per store shows positive growth rate, as increasing the number of outlets is only justified when it is backed by a strong cash management policy to meet the borrowings.   Analysis of the outcome of 2007: The Net sales of this particular year showed a decreasing trend. When compared to the revenue figures of 2006, the sale figure decreased by almost US $ 2 billion. (Annual reports Home Depot, 2007). This is a huge blow considering the expenses the company has incurred due to the expansion it made in the previous year. Significantly enough the total assets, total liabilities and also the stockholders equity has gone down. (Annual report Home Depot, 2007). It may be due to cover up this decline the company in this year also increased the number of outlets to cater to a wide range of market. In 2007 the net earnings of the company declined considerably to about US $ 4.4 billion. (Annual report Home Depot, 2007).This fact proves a lot as it shows that the company is not operating optimally and not using its assets to their full extent. From the previous study we have analyzed that the company by deploying its aggressive expansion strategies, has incurred a huge debt component. With the fall in the retail sales in the entire industry, the net sales of the company declined. The increased number of stores, coupled with the above mentioned fact led to the decline of comparable store sales by 6.7 %.( Annual report Home Depot, 2007). Even the number of transaction results, which was showing positive figures in the previous year, declined considerably to about 4.4 % this year. (Annual report Home Depot, 2007).In this case the company failed to predict the demand of the household and household appliances in the near future. The company constantly focused on its primary objective of growth, which led to these declining figures. The blow which had been struck, affected the gross profit of the company as well. The decrease in the gross profit in 2007 was about 2.1 %, whereas the gross profit of the previous year was showing an increasing trend of 9%.(Annual report Home Depot, 2007).This difference is huge and it is a major point of difference. This figure definitely exposes the operational weakness of the company, and points out its incapability of coping up to the economic condition and also the expansion policies. The other supporting fact of this assessment is the increase in the operating expense by 6.1 % and also the decrease in the operating income by 18.3 %.(Annual report Home Depot, 2007) The major contributing parameter of the increase of the operating expenses is the Sales & Administration cost. This means that the increased retail outlets have pulled up the admin cost to an almost undesirable extent. With the increased fixed assets the depreciation and amortization costs also increased in the year. Not only the operating income has gone down considerably but its contribution to the net sales has also declined. Which means the company’s operational level is not up to the desired standards and the profits that are being generated from the operations and insignificant to the total revenue earned, whereas ideally the contribution of the operating revenue should have been more. The importance of each of the activities (operating, investment, financial) lies in the amount of cash flow generated from those activities. Among these the operating activities can be considered as the most crucial, as it also shows how the firm is running its business. The cash flow coming from these activities not only determines the present standing of the company, but it also determines the future advancements of the company. The cash flow, which was generated from the operations, was only US $ 5.7 billion, which is lower by US $ 2 billion when compared to 2006. (Annual report Home Depot, 2007) The working capital structure of the company has changed considerably in the last year and these results reflect the same. The total current assets of the company decreased and most importantly the cash in hand figure declined in this year also. But when the fixed asset of the company is being compared, the amount of land, building and other fixed assets have increased significantly. Evidently the company is not showing proper asset utilization and cash management strategies, as while the market is going down, they are focusing on increasing their fixed asset components. Again though there is a slight decline in the current liabilities part, but the introduction of short-term debt in 2007, is definitely a sign to worry about. With less liquidity the company has to depend on its operating income to meet the short run debt figures.   Analysis of the outcome of 2008: The year 2008 showed more negative signs for the company. The net earning of the company dropped even further at this juncture, and it became only US $ 2.3 billion. (Annual Report, Home Depot, 2008). As mentioned earlier also the net sales again showed a steady decline in this year as well. The huge fall of about 7.8% on year-to-year basis was contributed by the global slowdown and also the fall of the U.S. residential market, but the main differentiating point of 2008 was the series of contraction strategies adapted by Home Depot. (Annual report Home Depot, 2008). The company closed down its fifteen stores and also cancelled the plans for installation of fifty new stores. These changes were inevitable as the only option that the company is now left with is shrinking in size, to coupe up with the challenges. (Annual report Home Depot, 2008). Strategically the company has stopped utilizing any capital on the infrastructure and expansion issues. The cash flow from the operation was about US $ 5.5 billion. (Annual Report, Home Depot, 2008). Though the figure indicates negative growth, but this reduction is nothing compared to the reduction of operating income in the previous year 2007. The lesser rate of reduction is due to the some protective measures taken on behalf of the company. But there is no overall improvement visible in the cash management or operational activities of the company. The operating cash flow is being used to pay back the short term debts and other debts (Current liabilities). The decrease in the operating income implies that there is a decrease in the operating profit of the company. Despite of the rationalization plans of the company the decline in the operating profit was about 11.4%.(Annual report Home Depot, 2008). The sales and administration expenses increases again the year of 2008 also along with the depreciation and the amortization charges. Also similar to the previous year the gross profit for the company also declined. Analyzing the scenario for the entire year it can be said that, there was hardly any evidence in favor of the fact that the company has improved on its operating capabilities. The strategies that are mostly being deployed by the company, reflects more or less a defensive mechanism for minimizing the negative impact.   Future: Thus after analyzing the operational activities and strategies taken by the company it is clear that though the external macro-economic factors are liable for the poor run of the company, but the company also has some difficulties in managing its current assets and liabilities. The assumption taken here is that the Home Depot’s sales revenue will increase by 20%. This will give a major boost to the company whose revenue is in the declining year after year, but it would not solve the entire problem. It has been consistently noticed that the liquidity of the company is constantly decreasing. In the current asset portion, this element has to be increased which will also help in paying off the current short term debts of the company. Increase in cash and decrease in debt will certainly improve the operating profit margin. Also the company needs to check the administration and sales expenses that it is incurring. For this the stores have to be utilized optimally. Store wise cost-revenue analysis is necessary to identify the proper utilization of resources. Expansion strategies should only be taken after doing thorough market survey of the area. With an increase of 20% in the sales revenue, the net sales figure would be US $ 85545 million. Ideally the increase of sales revenue would be contributed by increased gross profit. By judging the previous year’s figures the gross profit should be about 38.5 % of the total sales, which means it should amount to US $ 32934 (approx). It will show a huge increase in the operating profit margin which was about US $ 23990 in the year 2008. Increase in gross profit means decrease in operating expenses. The operating expenses by optimum utilization of resources can be brought down to about 5.5% of total sales. Thus the operating expense would only be US $ 4704. This figure is slightly greater than that of the previous year’s results, but considering the increase in sales revenue it is justifiable. These are the main changes that should be implemented in the cash management policies of the company. This also implies that the company needs to increase the liquidity (current assets) and side by side decrease the short-term debts (current liabilities). Conclusion: The study made about the company reveals that when the industry is showing an upward trend, most of the large companies often tend to neglect its operating efficiency part. As long as the revenues are coming, all the expansion possibilities and market share capture plans are viable. But when the industry falls all these areas of pain come into picture. The original business part (operation) should be sound enough to combat any given situation in the market. Loose cash management strategies often creates dilemma and the management often fails to identify the main areas of problem and adapts a random cost cutting policy. These steps are very common, but instead of taking a reactive strategy, the company must be more proactive in nature to adapt to the change. Every bit of current asset should be utilized efficiently to meet the current liabilities. None of the side should be allowed to grow out of proportion.     Reference: 1. Annual report of “Home Depot” , (2008), available at : < http://www.homedepotar.com/> (accessed on June 19, 2009) 2. Annual report of “Home Depot”, (2007), available at: < http://www.homedepotar.com/> (accessed on June 19, 2009). 3. Annual report of “Home Depot”, (2006), available at: < http://homedepotar.com/html/> (accessed on June 19, 2009). Read More