FIN301 • Chapter 4

Ratio Analysis

Use Home Depot financial statements to calculate profitability, liquidity, leverage, coverage, and efficiency ratios—and uncover the accounting relationships that connect the income statement, balance sheet, and cash flow statement.

Start here • 3-minute overview

What is financial ratio analysis?

Watch this short introduction before the lab. It explains how ratios turn financial-statement numbers into measures that help us evaluate performance, liquidity, leverage, and efficiency.

Video: 3 Minutes! Financial Ratios & Financial Ratio Analysis Explained & Financial Statement Analysis

Part 1 • Source data

Home Depot financial statement figures

Year ended January 30, 2011. Dollar amounts are in millions. Use these figures throughout the Chapter 4 ratio-analysis lab.

Income statement

Item	$m
Sales	67,977
COGS	44,693
Gross profit	23,284
Marketing, G&A	15,885
Depreciation	1,616
EBIT	5,783
Interest expense	530
EBT	5,253
Income taxes	1,927.85
Net income	3,325.15
Dividends	1,569

Balance sheet

Item	$m
Cash	545
Accounts receivable	1,085
Inventory	10,625
Other current assets	1,224
Current assets	13,479
Gross fixed assets	38,471
Accumulated depreciation	13,411
Net fixed assets	25,060
Other fixed assets	1,586
Total assets	40,125
Accounts payable	9,080
Short-term notes	1,042
Current liabilities	10,122
Long-term debt	11,114
Total liabilities	21,236
Common stock	3,894
Retained earnings	14,995
Total equity	18,889

CPA/exam convention: when a return or turnover ratio normally uses an average balance, use average beginning and ending balances if both are available. This lab has one Home Depot balance sheet, so any ratio marked simplified uses the ending balance only.

Part 2 • Equation map

Hidden and implied relationships students should be able to reconstruct

These equations are more useful than memorizing isolated line items because they let you solve for a missing number.

Balance sheet identityTA = TL + Equity
40,125 = 21,236 + 18,889

Asset structureTA = CA + Noncurrent Assets
40,125 = 13,479 + 26,646

Current assetsCA = Cash + A/R + Inventory + OCA

Net fixed assetsNFA = Gross FA − Accum. Dep.
25,060 = 38,471 − 13,411

Liability structureTL = CL + Long-term Debt
21,236 = 10,122 + 11,114

Equity structureEquity = Common Stock + Retained Earnings

Gross profitGP = Sales − COGS
23,284 = 67,977 − 44,693

Operating profitEBIT = GP − Operating Expenses − Dep.

Profit before taxEBT = EBIT − Interest
5,253 = 5,783 − 530

TaxesTax = EBT × Tax Rate
1,927.85 ≈ 5,253 × 36.70%

Bottom lineNI = EBT − Taxes

Retained earnings roll-forwardEnding RE = Beginning RE + NI − Dividends ± Other Adj.

Cash reconciliationEnding Cash = Beginning Cash + CFO + CFI + CFF

Indirect CFO coreCFO = NI + Noncash Charges ± Working-Capital Adjustments

Simplified capital spendingCapEx ≈ Ending NFA − Beginning NFA + Dep.
Use only under the exercise assumptions; acquisitions/disposals can change the relation.

Free cash flow conceptFCF ≈ CFO − CapEx
Definition can vary by course/company; always state the convention.

Part 3 • Interactive lab

Calculate the key ratios from the Home Depot statements

Enter a ratio as either a decimal or percentage when appropriate. Example: for 34.25%, you may enter 34.25% or 0.3425. For “times” ratios, enter the number only.

0 / 16 correct

Part 4 • Exam / CPA bridge

What to recognize without being told the formula

Profitability

Margins use sales in the denominator. Returns compare profit with assets or equity. CPA-style problems may require average assets/equity.

Liquidity

Current ratio uses all current assets. Quick ratio removes inventory and other less-liquid current assets. Working capital is a dollar amount, not a ratio.

Leverage & coverage

Debt ratios ask “how much is financed by creditors?” Coverage asks “how comfortably can earnings pay a fixed charge such as interest?”

Fast formula sheet

Category	Measure	Formula
Profitability	Gross margin	Gross profit / Sales
Profitability	Operating margin	EBIT / Sales
Profitability	Net profit margin	Net income / Sales
Profitability	ROA	Net income / Average total assets
Profitability	ROE	Net income / Average equity
Liquidity	Current ratio	Current assets / Current liabilities
Liquidity	Quick ratio	(Cash + A/R + qualifying quick assets) / Current liabilities
Liquidity	Working capital	Current assets − Current liabilities
Leverage	Debt ratio	Total liabilities / Total assets
Leverage	Debt-to-equity	Total liabilities / Equity
Leverage	Equity multiplier	Total assets / Equity
Coverage	Times interest earned	EBIT / Interest expense
Efficiency	Total asset turnover	Sales / Average total assets
Efficiency	Inventory turnover	COGS / Average inventory
Efficiency	Fixed asset turnover	Sales / Average net fixed assets
Distribution	Payout ratio	Dividends / Net income

Important: “Debt” can mean interest-bearing debt in some finance settings, while accounting ratio questions often use total liabilities. Read the problem’s definition. This lab labels the numerator explicitly as total liabilities.

Part 5 • Homework

Ten homework questions: solve the hidden relationships

How to use the homework hints: Complete each problem in your Excel submission first. If you need help remembering the relationship, move your mouse over Hint to reveal the equation. The hint gives only the equation—not the numerical setup or answer. Try the problem before using the hint.

Total assets are 40,125 and noncurrent assets are 26,646. Find current assets.
HintCA = TA − Noncurrent assets.
Current assets are 13,479. Cash = 545, A/R = 1,085, and inventory = 10,625. Find other current assets.
HintCA = Cash + A/R + Inventory + Other CA.
Gross fixed assets are 38,471 and net fixed assets are 25,060. Find accumulated depreciation.
HintNet FA = Gross FA − Accumulated depreciation.
Total liabilities are 21,236 and long-term debt is 11,114. Find current liabilities.
HintTotal liabilities = Current liabilities + Long-term debt.
Total assets are 40,125 and total liabilities are 21,236. Find total equity.
HintTA = TL + TE.
Sales are 67,977 and COGS is 44,693. Find gross profit.
HintGross profit = Sales − COGS.
EBIT is 5,783 and interest expense is 530. Find EBT.
HintEBT = EBIT − Interest.
Ending retained earnings are 14,995, net income is 3,325.149, and dividends are 1,569. Under a simplified no-other-adjustments assumption, find beginning retained earnings.
HintEnding RE = Beginning RE + NI − Dividends.
If TD/TE = 2.00, what is TD/TA?
HintTA = TD + TE. Express TA in terms of TE first, then form TD/TA.
If TD/TE = 2.00, what is TE/TA?
HintTA = TD + TE. Express TA in terms of TE first, then form TE/TA.