Equity, Cash Flow, and Notes Analysis: How to read the Statement of CHanges in Shareholder Equity - 4 Oct 2009

Sunday, October 4, 2009

(dw - I found this article on a blog posting and thought that there may be ECE members who would find it helpful in understand statement or communicating the details better)

Equity, Cash Flow, and Notes Analysis Paper

 Equity, Cash Flow, and Notes Analysis Paper

ACC529: Accounting for Managerial Decision Making



Home Depot was founded in 1978 in Atlanta, Georgia. Since then Home
Depot has become the second largest retailer in the United States. The
company assists both do-it-yourselfers and professionals with their
building and construction needs. Home Depot is well known within the
United States and globally as the third largest retailer.

Changes in Owner’s Equity

The statement of changes in owners’ equity is specifically designed to
show the details of the changes to owner’s equity over the course of a
year. This statement is a matrix that compares many factors and how
they affect the equity of the owner. In the case of Home Depot the top
portion of the matrix is used to record the amounts of the line items
and contains:

• Common Stock

• Paid-In Capital

• Retained Earnings

• Accumulated Other Comprehensive Income

• Unearned Compensation

• Treasury Stock

• Total Shareholders’ Equity

• Comprehensive Income



The left side of the matrix contains the line items for:

• Net Earnings

• Shares Issued Under Employee Stock Purchase and Option Plans

• Tax Effect of Sale of Option Shares by Employees

• Translations Adjustments

• Accumulated Other Comprehensive Income

• Unrealized Loss on Derivative

• Stock Options, Awards and Amortization of Restricted Stock

• Cash Dividends

• Total Stockholder’s Equity

• Comprehensive Income

• Balance



Statements of Cash Flows

The cash flow statement was prepared for a period starting February 3,
2003 and ending February 1, 2004. This statement uses the indirect
method to present data. The cash flows from operations section contains
the following:

• Net Earnings

• Depreciation and amortization

• Decrease (Increase) in Receivables

• Increase in Merchandise Inventories

• Increase in Accounts Payable and Accrued Liabilities

• Increase in Deferred Revenue

• (Decrease) Increase in Income Taxes Payable

• Increase (Decrease) in Deferred Income Taxes

• Other

• Net Cash Provided by Operations



The cash flows from investing activities section shows how cash is used for assets that are long term in nature and contains:

• Capital Expenditures

• Purchase of Assets from Off-Balance Sheet Financing Arrangement

• Payments for Businesses Acquired

• Proceeds from Sales of Business

• Proceeds from Sales of Property and Equipment

• Purchases of Investments

• Proceeds from Maturities of Investments

• Other

• Net Cash Used in Investing Activities



The cash flows from financing activities section shows the amount of
cash flow raised through the sale of stock and other debts and
contains:

• Repayments of Commercial Paper Obligations

• Proceeds from Long-Term Debt

• Repayments of Long-Term Debt

• Repurchase of Common Stock

• Proceeds from Sale of Common Stock

• Cash Dividends Paid to Stockholders

• Net Cash Used in Financing Activities



The last portion of the statement of cash flows shows how the overall cash flow went over the period and contains:

• Effect of Exchange Rate Changes on Cash and Cash Equivalents

• Increase (Decrease) in Cash and Cash Equivalents

• Cash and Cash Equivalents at Beginning of Year

• Cash and Cash Equivalents at End of Year

• Supplemental Disclosure of Cash



Managers should view these statements as a way to measure the company’s
vitals. Attention should be paid to the net cash provided by
operations. It is a simple way to see if the company is able to pay
expenses before investments or financing are mentioned. This amount
should be increasing from year to year to show strong growth. Another
area managers need to watch is the difference between the balances at
the beginning and end of the year in the consolidated statements of
stockholders’ equity and comprehensive income. This amount should be
positive and increasing; if it is not the company may need to address
negative issues such as taxes or a drop in sales that decreases
earnings.

Change Analysis

Managers can learn a great deal by performing a financial analysis. An
analysis of Home Depots financials found that the balance on both the
statement of cash flows and statement of stockholder’s equity increased
by 17% in regards to net earnings during fiscal year (FY) 2003 and 20%
in FY 2002. The statement of stockholder’s equity shows that
stockholder’s equity increased 13% in FY 2003 and 9.5% in FY 2002. The
return on stockholder’s equity in FY 2003 increased 21%, and in FY 2002
it increased 19%. (Home Depot, p. 24)

Also, when comparing the ending balances from the statement of cash
flows and statement of stockholder’s equity, we found that net earnings
increased by 17% in the fiscal year (FY) 2003. Management could use
this information to achieve the strategic goals of the organization.

That net cash from operations in FY 2003 increased 36% whereas in FY
2002 there was a drop of 19%. Net cash from investing activities
increased 36% in FY 2003 while in FY 2002 there was drop of 15%. The
cash and cash equivalent balances increased 878% from $289 million to
$2,826 million in FY 2003 while in FY 2002 there was a decrease of
84.5% (Home Depot, p. 25). Even through the recession Home Depot has
posted gains in earnings and owner’s equity balances for the last 3
fiscal years. This up-wards trend is based mainly on Home Depots
aggressive expansion strategies and the rising popularity of
do-it-yourself reality shows.

Financial Statement Notes

Footnotes to the financial statement are used to highlight information
that is important to investors, to present a clearer picture to users,
or expand on financial statement details. Only relevant information is
footnoted, such as any outstanding debts or extraordinary items that
may have taken place during the period. Being able to analyze these
footnotes gives investors an edge in identifying early warning signs of
company difficulty so they can then focus on the relevant information
within the financial statements. These footnotes also highlight any new
accounting rules that could be of significance to the company



in the near or distant future. Typically, there are two types of footnotes:

1. Accounting Methods – This type of footnote identifies and explains
the major accounting policies of the business (Intro, 2002, 7).

2. Disclosures – This type of footnote provides additional disclosure
that simply could not be put in the financial statements (Intro, 2002,
7).



Accounting policies can also be disclosed in the footnotes. Examples
include: 1) how the company establishes allowances for losses based on
loans to customers, 2) what the company has in reserve based on retain
earning that is not available to pay dividends, 3) how the company
accounts for loans, and 4) what depreciation method is used for
furniture and fixtures. There are other footnotes that we recommend
investors should pay special attention to:

• Pension Risks – If these types of plans are under funded then the
company will be unable to pay pensioners the money that is due to them.


• Depreciation and Amortization Methods Used – This section states that
Home Depot uses the straight-line method to depreciate for assets based
on useful life. One concern here could be that the asset may not be
able to produce as much as useful life progresses.



Some notes will always be included, such as a summary of significant
accounting, which states the period of the company’s fiscal year.
Another note states inventory valuation method. Home Depot uses the
first in first out (FIFO) method. FIFO computes cost of good sold using
the value of the oldest inventory first. This method tends to be a more
conservative method in times of rising prices. All positives being
explored, there is one thing to be aware of when dealing with
footnotes. These notes are written by managers who treat them more like
a FASB requirement thus they are extremely careful in how they word
each item as to not create a panic among investors.



Other Financial Information

Another section that is extremely valuable to investors is the
Management’s Discussion and Analysis (MD&A). This section of a
company’s annual report is designed to meet three principal objectives:


1. To provide a narrative explanation of a company’s financial
statements that enables investors to see the company through the eyes
of management.

2. To enhance the overall financial disclosure and provide the context within which financial information should be analyzed.

3. To provide information about the quality of, and potential
variability of, a company’s earnings and cash flow, so that investors
can ascertain the likelihood that post performance is indicative of
future performance (U.S. Securities and Exchange Commission).



According to Home Depot’s MD&A, located in their 2003 Annual
Report, “our financial condition remains strong as evidence by our $2.9
billion in Cash and Short-Term Investments at February 1, 2004. At the
end of the FY 2003, our total debt-to-equity ratio remains the lowest
in our industry at 6.1% and our return on invested capital was 20.4%
compared to 18.8% at the end of FY 2002, a 160 base point improvement”
(Home Depot, p. 14). Besides ratios, various charts are provided to
show comparisons of different finical statement details and other
operating comparisons. The MD&A also provides detailed breakdowns
and reasoning behind the key components of the various financial
statements in easy to understand terms that relate specifically to the
company.

Another topic discussed in great detail is the opening of new stores;
for this fiscal year the company opened an additional 175 stores. As
quoted from the documentation “in order to meet our customer service
objectives, we strategically open stores near market areas served by
existing stores to enhance service levels, gain incremental sales, and
increase market penetration” (Home Depot, p. 15).

In addition, there is also a section that deals with Home Depot’s
unique in-store initiatives. These initiatives are designed to “enhance
our customer’s shopping experience” (Home Depot, p. 15). These
initiatives provide excellent service and resources to the
do-it-yourselfers and Home Depot Pro customers.

An example of how this information can be beneficial to investors can
be seen in the company’s debt-to-equity ratio. Home Depots total
debt-to-equity ratio is 6.1%. This ratio is used often by investors to
measure solvency and as an indicator as to how much the company is
leveraged. The reason this ratio is so important is that it tells
investors how willing a company is to fund its operations with debt as
opposed to equity. A company with a low ratio is a solid investment as
there is a strong chance that loans made to the company will be repaid
whereas a company with a high ratio is more likely to default.

By publishing this variety of information in the MD&A Hope Depot
provides investors with a plethora of information to help them make
well-informed decisions regarding the company. Not only can investors
compare these GAAP ratios but they can also compare the non-standard
items, like marketing strategy, to that of Home Depot’s competitors to
see if their specific strategy appears to be sound and well planned. As
a source of comparative financial information the MD&A information
provided by Home Depot is extremely valuable. According to the SEC “we
believe that management’s most important responsibilities include
communicating with investors in a clear and straightforward manner and
the MD&A is a critical component in that communication (U.S.
Securities and Exchange Commission).

Conclusion

According to the analysis that we have done of Home Depots financials
we believe that the company is well positioned for future re-investment
and growth in FY 2004. By analyzing their financial statements we have
determiend that this is an extremely strong company and we recommend
that since the funds are available Home Depot should continue to expand
into new markets and new locations thus continuing the winning
strategies used in previous years and continuing to meet strategic
goals.



References

Home Depot (n.d.). 2003 Annual Report. Retrieved September 5, 2004, from http://ir.homedepot.com/downloads/HD_2003_AR.pdf

Intro to Fundamental Analysis Tutorial (2002), Retrieved September 7,
2004 from
http://www.investopedia.com/pdf/tutorials/fundamentalanalysis_intro.pdf


U.S. Securities and Exchange Commission (n.d.). Interpretation:
Commission Guidance Regarding Management’s Discussion and Analysis of
Financial Condition and Results of Operations. Retrieved September 5,
2004, form http://www.sec.gov/rules/interp/33-8350.htm

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