How Bankers Analyze Financial Statements

Introduction

Home Depot's sales rose 3.2% in fiscal 2025, the year to February 1, 2026, to $164.7 billion. Read on its own, the figure says the business grew. Read with the rest of the annual report, it says something different. Acquisitions added about $6.3 billion of sales; the previous year had included an extra week worth about $2.5 billion; and comparable sales, the measure of the existing business, rose just 0.3%. Earnings per share fell 4.6%. Return on invested capital (ROIC), which Home Depot reports itself, dropped from 31.3% to 25.7%. And its return on equity was well over 100%, a number that says more about decades of share buybacks than about the business.

Every headline figure in a set of financial statements has parts, and the work of analysis is separating them. Bankers do this for every company they cover, pitch or value, in roughly the same order: understand the business and how it reports, then growth, margins, cash conversion, returns and the balance sheet, before comparing the company with its peers. Home Depot's fiscal 2025 annual report supplies the worked example at every step.

Ratios mean little without knowing what the company does and how it accounts for it. The first reading of a 10-K is of the business description, the segments and the accounting policies, the parts described in how to read a 10-K and 10-Q. Home Depot sells home improvement products through 2,359 stores and online, to do-it-yourself customers and to professional contractors, and it has bought two large distributors to professionals, SRS in 2024 and GMS in 2025. A business with that mix has retail economics in one part and distribution economics in another, with different margins, working capital and growth rates.

Three questions about the reporting basis come next. The first is the reporting standard the statements are prepared under, since every company in a comparison has to be measured on the same basis. The second is the fiscal calendar. Many retailers use a 52-week or 53-week year, so one year in five or six has an extra week; Home Depot's fiscal 2024 had 53 weeks and fiscal 2025 had 52, which flattered the prior year by about $2.5 billion of sales. The third is the period of analysis. For valuation, bankers often build last twelve months figures from the latest annual and quarterly reports, the method covered in LTM figures from filings, so that every company in a comparison is measured over the same recent period.

The Segment Note and Accounting Policies

The segment note shows where the profits are. Companies report results for each segment as their management reviews them, and the disclosures described in segment reporting often reveal that a group's average margin hides a high-margin core and a low-margin addition, or the reverse. For a company that has just made large acquisitions, the segment figures are also the first evidence of how the acquired businesses are performing.

The accounting policies note deserves the same attention. Choices that are legitimate under the rules can still change the numbers materially: whether revenue is recorded gross or net of a partner's share, which development or software costs are capitalized rather than expensed, how inventory is costed, over what lives assets are depreciated and how leases are classified. Two companies with identical economics can report different margins and asset bases because of those choices, so noting them at the start saves misreading the ratios later.

Revenue growth is the first number most people look at and the one that most needs breaking down. Bankers separate it into organic growth, from the existing business, and growth from acquisitions, disposals, currency and calendar effects. Each has different implications for the future: organic growth reflects demand and execution, while acquired growth reflects capital spent, and currency and calendar effects reverse.

Organic growth

The change in revenue from the business a company owned in both periods, excluding the effects of acquisitions and disposals, and usually of currency movements and differences in the number of selling days or weeks. Retailers report a version called comparable sales, which covers stores and channels open for at least a year.

Home Depot's fiscal 2025 sales rose by $5.2 billion. Acquisitions contributed about $6.3 billion and the absence of the 53rd week took away about $2.5 billion, so new stores and the existing business added roughly $1.4 billion. Comparable sales rose 0.3%: the number of comparable customer transactions fell 1.0% while the average ticket rose 1.4%. In other words, the core business grew through price and mix rather than volume, in a weak housing market, and the reported growth came almost entirely from buying other companies.

Price, Volume and Mix

The split between price and volume matters as much as the total. Growth from higher prices may reflect inflation, pricing power or a shift in mix toward more expensive products; growth from volume reflects more customers or more purchases. A company whose volumes are falling while prices rise is more exposed to a downturn than its revenue line suggests. Retailers disclose transactions and ticket; manufacturers often disclose price, volume and mix in their revenue bridges; and companies with foreign operations disclose currency effects, the subject of foreign currency translation.

Acquired Growth

When acquisitions drive growth, the reported figures compare a year with the acquired business for part of the year against a year with it for all or none of it. Home Depot's fiscal 2025 includes SRS for the full year and GMS from September 2025. Pro forma figures, which show the combined business as if it had been owned throughout, are the better basis for measuring growth, as explained in pro forma financial statements. Calendar effects reach the bottom line too: Home Depot estimates that the extra week in fiscal 2024 alone added about $0.30 to that year's adjusted earnings per share.

Margins come next, from the top of the income statement down. Gross margin shows pricing and the cost of goods; operating expenses show the cost of running the business; operating margin and the margin on EBITDA (earnings before interest, taxes, depreciation and amortization) show the result; and net margin adds financing and taxes. Home Depot's gross margin was 33.3%, almost unchanged from 33.4%. Selling, general and administrative expenses rose from 18.0% to 18.6% of sales, and operating margin fell from 13.5% to 12.7%. The definitions and drivers of each margin are set out in profitability margins.

The question behind every margin change is why. Home Depot's acquisitions brought businesses with their own cost structures, integration costs and a larger amortization charge on acquired intangible assets, which rose from $425 million to $607 million. Flat comparable sales gave little operating leverage, the tendency of margins to rise when sales grow faster than largely fixed costs and to fall when they do not. Interest expense rose with the debt taken on for the deals, so earnings per share fell faster than operating income.

Recurring and One-Off Items

Before margins are compared over time or with peers, they are cleaned of items that will not recur and of accounting effects that differ between companies. Restructuring charges, impairments, gains on sales and litigation costs are the usual candidates, alongside the amortization of acquired intangibles that most acquirers exclude from their adjusted figures. Home Depot's adjusted earnings per share, which exclude only the amortization of acquired intangibles, net of tax, were $14.69 against $15.24 the year before, according to its fourth quarter earnings release. How such figures are built, and when they mislead, is the subject of non-GAAP measures; the deeper diligence version is a quality of earnings review.

Earnings are an accounting measure; the business is worth the cash it generates. The third step compares profit with cash flow. Home Depot's operating cash flow fell from $19.8 billion to $16.3 billion, while net income fell only from $14.8 billion to $14.2 billion. After $3.7 billion of capital expenditure, free cash flow was about $12.6 billion, or 89% of net income, down from 110% the year before.

Working Capital and Capital Spending

Working capital metrics turn those movements into days. Inventory turnover fell from 4.7 to 4.4 times, which Home Depot attributes to higher average inventory, equivalent to inventory sitting for about 83 days rather than 78. Receivable days and payable days complete the cash conversion cycle, and changes in each are usually the first sign of a shift in a business's terms of trade, the mechanics covered in working capital on the cash flow statement. Capital spending is compared with depreciation and amortization: Home Depot spent $3.7 billion against $4.1 billion of depreciation and amortization, a ratio below one that reflects the acquired intangibles being amortized rather than underinvestment in stores.

Free cash flow has several definitions, before or after interest, leases and stock-based compensation, and choosing one consistently is part of the work. The alternatives, and when each is used, are compared in free cash flow definitions.

Cash Conversion Over Several Years

One year of cash flow is rarely enough. Working capital swings back and forth, and a single year can flatter or penalize conversion. Home Depot's operating cash flow was $21.2 billion in fiscal 2023, helped by a $4.1 billion reduction in inventory after the supply chain build-up of earlier years; the same line then consumed $0.7 billion in fiscal 2024 and $1.5 billion in fiscal 2025. Averaging conversion over three to five years, or comparing cumulative free cash flow with cumulative net income, gives a fairer picture of how much of the business's profit reaches its owners.

The fourth step asks how much capital the business needs to generate its profits, and how that capital is financed. Return on invested capital is the most useful single measure: operating profit after tax divided by the debt and equity invested. Home Depot's own calculation fell from 31.3% to 25.7%, primarily because average invested capital rose with the debt that financed SRS and with equity that grew while the company paused share repurchases. A large acquisition almost always lowers ROIC at first, because the price includes goodwill and intangibles that the target never carried; the question is whether the acquired profits grow into it. The ratios and their trade-offs are compared in return ratios: ROE, ROA and ROIC.

The decomposition that separates margin, asset turnover and leverage is set out in DuPont analysis; applied to Home Depot, it shows a business with high margins and fast asset turnover whose return on equity is then multiplied many times by a balance sheet funded largely with debt.

Capital Allocation

The cash flow statement also shows what management did with the cash. Over fiscal 2025, Home Depot's $12.6 billion of free cash flow was more than absorbed by $9.2 billion of dividends and $5.4 billion spent on acquisitions, mainly GMS, with the gap covered mainly by net new borrowing. In fiscal 2024, it spent $17.6 billion on SRS, financed largely with $10.0 billion of new long-term debt; in fiscal 2023, before the acquisitions, it had repurchased $8.0 billion of shares. A three-year view of the uses of cash shows a company that has shifted from returning cash to shareholders to buying growth, and the returns on those acquisitions are what the next few years of ROIC will measure.

Leverage, Coverage and Liquidity

The balance sheet sets the limits within which the business operates. Home Depot ended the year with about $55.8 billion of debt, including short-term borrowings and finance leases, and $1.4 billion of cash. Net debt of about $54.4 billion was roughly 2.2 times its EBITDA of about $25.0 billion, up from 2.0 times, and operating income covered interest expense about 8.7 times. Operating lease liabilities of $9.6 billion sit outside that debt figure, and whether to include them, as rating agencies do, changes the leverage ratio. The definitions lenders use, and the adjustments behind them, are set out in leverage and coverage ratios.

Goodwill and intangible assets, $32.7 billion after the two acquisitions, are now more than two and a half times Home Depot's book equity. That does not make the company weak, but it means tangible book value is negative and that the value of a large part of the balance sheet rests on the acquired businesses performing. Liquidity is the last check on the balance sheet. Home Depot had about $9.4 billion of debt due within a year, $4.5 billion of short-term borrowings and $5.0 billion of current installments of long-term debt, against $1.4 billion of cash. For a company generating its level of cash flow, with access to the commercial paper and bond markets, that is routine; for a weaker borrower, the same mismatch would be the central risk. Current and quick ratios, which compare current assets with current liabilities, frame that question, but the maturity schedule and the company's access to funding answer it.

The Footnotes

Much of the information needed for these steps sits in the notes rather than the statements: debt maturities and covenants, lease commitments, pension obligations, contingencies, the tax note and the business combination note. Reading them, in the order described in reading the footnotes, is also where most problems surface. Receivables or inventory growing faster than sales, reserves falling as a share of sales, frequent changes in segment definitions or large items reclassified out of operating results are the patterns listed in accounting red flags.

The final step is comparison: with the company's own history and with its peer group. Both require putting the figures on the same basis. For history, that means removing calendar effects, acquisitions and one-off items. For peers, it means aligning fiscal years, definitions of EBITDA and adjusted earnings, the treatment of leases and stock-based compensation, and, for companies reporting under a different framework, the adjustments described in adjusting non-US reporters for US peer comparisons. Only then do differences in margins, returns or leverage say something about the businesses rather than their accounting.

Choosing the peers matters as much as adjusting them. The obvious comparison for Home Depot is Lowe's, the other large US home improvement retailer, which made its own acquisitions of suppliers to professional builders in 2025. But after SRS and GMS, part of Home Depot looks more like a building products distributor, with lower gross margins and more working capital than a retailer. A comparison with retailers alone would attribute to performance what is really a change in mix.

The Summary Table

A one-page summary of the key measures is the usual output. For Home Depot, it looks like this:

Read together, the figures describe a highly profitable business that has used debt to buy growth in a weak market: margins and returns down, leverage up, cash conversion lower, partly for reasons of timing, and the core business roughly flat. Each of those is a question for management or for the valuation: whether margins recover as the acquisitions are integrated, whether inventory normalizes, and how quickly leverage comes back down.

The same sequence applies whatever the company or the purpose. For a valuation, it decides which normalized figures go into the multiples and the forecast, as in comparable company analysis. For a debt financing, it puts more weight on cash flow, leverage and coverage. For an acquisition, it is the first draft of the diligence questions. In each case, the discipline is the same: break every headline figure into its parts, and explain each part before drawing a conclusion.