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Financial Statement Analysis

# Financial Statement Analysis

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11/06/2011

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Financial Statement Analysis Methods: Horizontalvs. Vertical Analysis
Introduction
Financial statement information is used by both external and internal users,including investors, creditors, managers, and executives. These users mustanalyze the information in order to make business decisions, sounderstanding financial statements is of great importance. Several methodsof performing financial statement analysis exist. This article discusses two of these methods: horizontal analysis and vertical analysis.
Horizontal Analysis
Methods of financial statement analysis generally involve comparing certaininformation. The horizontal analysis compares specific items over a numberof accounting periods. For example, accounts payable may be comparedover a period of months within a fiscal year, or revenue may be comparedover a period of several years. These comparisons are performed in one of two different ways.
Absolute Dollars
One method of performing a horizontal financial statement analysiscompares the absolute dollar amounts of certain items over a period of time.For example, this method would compare the actual dollar amount of operating expenses over a period of several accounting periods. This methodis valuable when trying to determine whether a company is conservative orexcessive in spending on certain items. This method also aids in determiningthe effects of outside influences on the company, such as increasinggas prices or a reduction in thecostof materials.
Percentage
The other method of performing horizontal financial statement analysiscompares the percentage difference in certain items over a period of time. The dollar amount of the change is converted to a percentage change. Forexample, a change in operating expenses from \$1,000 in period one to\$1,050 in period two would be reported as a 5% increase. This method isparticularly useful when comparing small companies to large companies.
(1050 – 1000)/1000 X 100 = 5%
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Financial Statement Analysis

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Vertical Analysis
The vertical analysis compares each separate figure to one specific figure inthe financial statement. The comparison is reported as a percentage. Thismethod compares several items to one certain item in the same accountingperiod. Users often expand upon vertical analysis by comparing the analysesof several periods to one another. This can reveal trends that may be helpfulin decision making. An explanation of Vertical analysis of the incomestatement and vertical analysis of the balance sheet follows.
Income Statement
Performing vertical analysis of the income statement involves comparingeach income statement item to sales. Each item is then reported as apercentage of sales. For example, if sales equals \$10,000 and operatingexpenses equals \$1,000, then operating expenses would be reported as 10%of sales.
1000/10,000 X 100 = 10%
Balance Sheet
Performing vertical analysis of the balance sheet involves comparing eachbalance sheet item to total assets. Each item is then reported as apercentage of total assets. For example, if cash equals \$5,000 and totalassets equals \$25,000, then cash would be reported as 20% of total assets.
References
Edmonds, C., Edmonds, T., Olds, P., & Schneider, N. (2006). "FundamentalManagerial Accounting Concepts." 3rd ed. New York: McGraw-Hill Irwin.
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Session 1: Vertical and Horizontal Analysis Technique
Session Learning Outcomes
Learners will understand and be appreciative on the use of the horizontaland vertical analysis technique while analyzing the financial statementsinformation, its application and interpretation.
Important Learning Terms
Financial analysis

Horizontal financial statements analysis

Vertical financial statements analysis

Cross sectional financial statement analysis

Introduction
Financial analysis
: is a process which involves reclassification andsummarization of information through the establishment of ratios andtrends.
Analysis of financial statement:
Refers to the examination of the statementsfor the purpose of acquiring additional information regarding the activities of the business.The users of the financial information often find analysis desirable for theinterpretation of the firm’s activities.
Note: The financial statement to be used for the purpose of analysis should be the audited ones. The audited financial statements give the analyst theauditor’s statement as to whether the records represent a fair view of thecompany’s affairs.The Objectives of Financial Statement Analysis
The overall objective of financial statement analysis is the examination of afirm’s financial position and returns in relation to risk. This must be donewith a view to forecasting the firm’s future prospective.For the purpose of understanding, the following financial statements will beused.
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