Fundamentals of Accountancy, Business, and Management 2

Analysis and Interpretation of

Financial Statements 1
Content Standards
The learners demonstrate an understanding of the methods or tools of analysis of financial
statements to include horizontal analysis and vertical analysis.

Performance Standards
1. Solve exercises and problems that require computation and interpretation using
horizontal analysis and vertical analysis.
2. Using the downloaded sample financial statements, learner performs horizontal and
vertical analysis.

Learning Competency
Perform vertical and horizontal analyses of financial statements of a single proprietorship.

Specific Learning Outcome

At the end of this lesson, the learners will submit a horizontal and vertical analysis
evaluation of sample company.

INSTRUCTION/DELIVERY (120 MINS)

Defining the following:

• Financial statement (FS) analysis is the process of evaluating risks, performance, financial
health, and future prospects of a business by subjecting financial statement data to
computational and analytical techniques with the objective of making economic decisions.
There are three kinds of FS analysis techniques:
- Horizontal analysis
- Vertical analysis
- Financial ratios
(Note: Inform the learners that this lesson will focus on horizontal and vertical analysis. The
financial ratios will be discussed in the next lesson.)
• Horizontal analysis, also called trend analysis, is a technique for evaluating a series of
financial statement data over a period of time with the purpose of determining the increase or
decrease that has taken place. This will reveal the behavior of the account over time. Is it
increasing, decreasing or not moving? What is the magnitude of the change? Also, what is the
relative change in the balances of the account over time?
- Horizontal analysis uses financial statements of two or more periods.
 - All line items on the FS may be subjected to horizontal analysis.
- Only the simple year-on-year (Y-o-Y) grow this covered in this lesson.
- Changes can be expressed in monetary value (peso) and percentages computed by using
the following formulas:
• Peso change=Balance of Current Year-Balance of Prior Year
• Percentage change= (Balance of Current Year-Balance of Prior Year)/(Balance of Prior
Year)
• Example:

✓Peso change = P250,000 - P175,000 = P75,000

✓Percentage change = (P250,000 - P175,000) / P175,000 = 42.86%
✓This is evaluated as follows:
Sales increased by P75,000. This represents growth of 42.86% from 2013 levels.

• Vertical anaylsis, also called common-size analysis, is a technique that expresses each
financial statement item as a percentage of a base amount.
- For the SFP, the base amount is Total Assets.
• Balance of Account / Total Assets
• From the common-size SFP, the analyst can infer the composition of assets and the
company’s financing mix.
• Example

✓The above may be evaluated as follows:

The largest component of asset is Equipment at 39.3%. Cash is the smallest
component at 14%. On the other hand, 50% of assets are financed by debt and the other half is
financed by equity
 - For the SCI, the base amount is Net Sales.
• Balance of Account / Total Sales.
• This will reveal how “Net Sales” is used up by the various expenses.
• Net income as a percentage of sales is also known as the net profit margin.
• Example

✓The above may be evaluated as follows:

• The cost of goods sold is 44% of sales. The company has a gross profit rate of
55.5%. Operating expenses is 22% of sales.
• The company earns income of P 0.33 for every peso of sales. Gross profit
generated for every peso of sale is P 0.555 –

The use of common-size financial statements allows the comparison of two companies of
different sizes. This is because the SFP and SCI comparative information are standardized as a
percentage of assets and sales, respectively.

PRACTICE (50 MINS)