Evaluation of credit rating
Memorandum: Credit Rating assignment: Home Depot, Inc.
After analysing the financial statements of Home Depot, we have allocated a “C” rating of credit risk. The proposal is to start with the “C” rating and then to either upgrade to a “B” rating or to be down graded to a “D” rating. The reason for such a decision is discussed below. Home Depot has a current ratio of 1.19 to 1 which means that it’s current assets covers it’s current liabilities by 1.19 times. This is the lowest that it had been for the last 10 years against an average of 1.61. A current ratio of 2 or higher would usually be a qualifier for good credit risk. The low current ratio of Home Depot will increase the credit risk. Working capital is another measure that can be used to analyse credit risk in conjunction with the current ratio. The working capital for 2005 was $ 2.445 million and $ 3.818 million for 2004. This shows that the company has excess monetary recourses to cover the liabilities that are to be paid in the short term. The quick ratio of Home Depot is 1.13 to 1 for 2005 and 1.31 to 1 for 2004 respectively. The calculation includes the inventory. It was included because the operating cycle of Home Depot was calculated to be 13 days (Annexure 3 point 7), which is very quick. The quick ratio for Home Depot is affecting the credit risk positively as analyst view this ratio from 1.0 and upwards to be satisfactory (Williams, Haka, Bettner, Carcello, 2008). The dept ratio is another very important ratio which must be analysed as it indicates the long term risk of creditors. The dept ratio for Home Depot is 40% for 2005 and 38% for 2004 respectively. The rule of thumb is that the dept ratio should be below 50%, (Williams et al, 2008). In the case of Home Depot this is within the required range impacting positively on the credit rating. The gross profit percentage for the last 3 years had been stable at around 33%. For most merchandising...
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