Home Depot Case Summary
Cost behavior of a firm, such as Home Depot, is a direct relationship between their fixed and variable costs. Apparently, Home Depot was taking advantage of their operating leverage in the years prior to 2006 and found this approach to be profitable. In fact, it appears they were gambling with the fact of whether the market was in a lull and would recover. Based upon their decline in 2007, they had underestimated the market.
A major activity of management is to plan and control costs of the firm. Assuming, Home Depot sold in bulk to contractors during the prosperous times, they had anticipated their fixed costs and projected the minimum sales to cover these costs. However, when the same contractors did not purchase according to prior …show more content…
For example, their depreciation on inventory, salaries, utilities, and facility costs may have been fixed. However, they may have had a bonus structure, delivery costs, interest and other items, which were variable.
Management of Home Depot could have invoked discretionary cost limitations during this time for items such as training, travel, and other expenses deemed non-essential. Additionally, they could have used opportunity cost for items such as selling their buildings and renting from new owners. However, their committed costs could not be reduced enough to offset their decline in sales for items such as salaries or insurance.
Last, it does not appear that Home Depot took action soon enough to protect their margin of safety. Ultimately, the difference between their budgeted sales and break-even sales was not estimated appropriately for the decline. In fact, while their revenues were just 3% less, it is the 21% earnings loss that identifies this shortfall. As a result, there was not cushion between projected and break-even to account for the reduction in sales. Apparently, when the decline began in 2006, the accountants did not recalculate their margin of safety to budget for the decrease. Conservatively, had they compared year over year sales for the last five years, they may have noticed the
A major activity of management is to plan and control costs of the firm. Assuming, Home Depot sold in bulk to contractors during the prosperous times, they had anticipated their fixed costs and projected the minimum sales to cover these costs. However, when the same contractors did not purchase according to prior …show more content…
For example, their depreciation on inventory, salaries, utilities, and facility costs may have been fixed. However, they may have had a bonus structure, delivery costs, interest and other items, which were variable.
Management of Home Depot could have invoked discretionary cost limitations during this time for items such as training, travel, and other expenses deemed non-essential. Additionally, they could have used opportunity cost for items such as selling their buildings and renting from new owners. However, their committed costs could not be reduced enough to offset their decline in sales for items such as salaries or insurance.
Last, it does not appear that Home Depot took action soon enough to protect their margin of safety. Ultimately, the difference between their budgeted sales and break-even sales was not estimated appropriately for the decline. In fact, while their revenues were just 3% less, it is the 21% earnings loss that identifies this shortfall. As a result, there was not cushion between projected and break-even to account for the reduction in sales. Apparently, when the decline began in 2006, the accountants did not recalculate their margin of safety to budget for the decrease. Conservatively, had they compared year over year sales for the last five years, they may have noticed the