For example, suppose XYZ Corporation has gross sales of $5 million and cost of goods sold of $1 million

and general and administrative expenses of $2 million and a 25% tax rate, its income statement will look
like this if vertical analysis is used:

Sales 5,000,000 100%

Cost of goods sold 1,000,000 20%

Gross profit 4,000,000 80%

General and Administrative Expenses 2,000,000 40%

Operating Income 2,000,000 40%

Taxes (%25) 500,000 10%

Net income 1,500,000 30%

Horizontal analysis

Horizontal analysis is used in financial statement analysis to compare historical data, such as ratios, or
line items, over a number of accounting periods. Horizontal analysis can either use absolute
comparisons or percentage comparisons, where the numbers in each succeeding period are expressed
as a percentage of the amount in the baseline year, with the baseline amount being listed as 100%. This
is also known as trend analysis.

For example, assume an investor wishes to invest in company XYZ. The investor may wish to determine
how the company grew over the past year. Assume that in company XYZ's base year, it reported net
income of $10 million and retained earnings of $50 million. In the current year, company XYZ reported a
net income of $20 million and retained earnings of $52 million. Consequently, it has an increase of $10
million in its net income and $2 million in its retained earnings year over year. Therefore, company ABC's
net income grew by 100% (($20 million - $10 million) / $10 million * 100) year over year, while its
retained earnings only grew by 4% (($52 million - $50 million) / $50 million * 100).

Period 1 (Base) Period 2 (Current Period) Change% Change

Net Income $10 million $20 million + $10 million 100%

Retained Earnings $50 million $52 million + $2 million 4%

Horizontal analysis allows investors and analysts to see what has been driving a company's financial
performance over several years and to spot trends and growth patterns. This type of analysis enables
analysts to assess relative changes in different line items over time and project them into the future. An
analysis of the income statement, balance sheet, and cash flow statement over time gives a complete
picture of operational results and reveals what is driving a company’s performance and whether it is
operating efficiently and profitably.

Ratio Analysis

Ratio analysis is a quantitative method of gaining insight into a company's liquidity, operational
efficiency, and profitability by studying its financial statements such as the balance sheet and income
statement. Ratio analysis is a cornerstone of fundamental equity analysis.

Ratio Analysis Categories

The various kinds of financial ratios available may be broadly grouped into the following six silos, based
on the sets of data they provide:

Liquidity Ratio

Liquidity ratios are an important class of financial metrics used to determine a debtor's ability to pay off
current debt obligations without raising external capital. Liquidity ratios measure a company's ability to
pay debt obligations and its margin of safety through the calculation of metrics including the current
ratio, quick ratio, and operating cash flow ratio.

The current ratio is a liquidity ratio that measures a company’s ability to pay short-term obligations or
those due within one year. It tells investors and analysts how a company can maximize the current
assets on its balance sheet to satisfy its current debt and other payables.

Current Ratio=

Current liabilities

Current assets

The current ratios of three companies—Apple, Walt Disney, and Costco Wholesale—are calculated as
follows for the fiscal year ended 2017:
 The quick ratio is an indicator of a company’s short-term liquidity position and measures a company’s
ability to meet its short-term obligations with its most liquid assets.

Since it indicates the company’s ability to instantly use its near-cash assets (assets that can be converted
quickly to cash) to pay down its current liabilities, it is also called the acid test ratio. An "acid test" is a
slang term for a quick test designed to produce instant results.

The formula to calculate the quick ratio is:

\begin{aligned} &QR=\frac{CE+MS+AR}{CL}\\ &\text{Or}\\ &QR=\frac{CA-I-PE}{CL}\\ &\textbf{where:}\\

&QR=\text{Quick ratio}\\ &CE=\text{Cash } \&\text{ equivalents}\\ &MS=\text{Marketable securities}\\
&AR=\text{Accounts receivable}\\ &CL=\text{Current Liabilities}\\ &CA=\text{Current Assets}\\ &I=\
text{Inventory}\\ &PE=\text{Prepaid expenses} \end{aligned}

QR=

CL

CE+MS+AR

Or

QR=

CL

CA−I−PE

where:

QR=Quick ratio

CE=Cash & equivalents

MS=Marketable securities

AR=Accounts receivable

CL=Current Liabilities
CA=Current Assets

I=Inventory

PE=Prepaid expenses

(in $millions) Procter & Gamble Johnson & Johnson

Quick Assets (A) $15,013 $38,761

Current Liabilities (B) $33,132 $42,439

Quick Ratio (A/B) 0.45 0.91

The operating cash flow ratio is a measure of how readily current liabilities are covered by the cash flows
generated from a company's operations. This ratio can help gauge a company's liquidity in the short
term.

Using cash flow as opposed to net income is considered a cleaner or more accurate measure since
earnings are more easily manipulated.

Operating cash flow ratio=

Current liabilities 2

Operating cash flow 1

A solvency ratio is a key metric used to measure an enterprise’s ability to meet its long-term debt
obligations and is used often by prospective business lenders. A solvency ratio indicates whether a
company’s cash flow is sufficient to meet its long-term liabilities and thus is a measure of its financial
health. An unfavorable ratio can indicate some likelihood that a company will default on its debt
obligations.

The interest coverage ratio is a debt and profitability ratio used to determine how easily a company
can pay interest on its outstanding debt. The interest coverage ratio is calculated by dividing a
company's earnings before interest and taxes (EBIT) by its interest expense during a given period.

The formula used is:

Interest Coverage Ratio=

Interest Expense 2
EBIT 1

where:

EBIT=Earnings before interest and taxes

ABC Company earnings $5,000,000 before interest and taxes in its most recent reporting month. Its
interest expense for that month is $2,500,000. Therefore, the company's interest coverage ratio is
calculated as:

$5,000,000 EBIT ÷ $2,500,000 Interest expense

= 2:1 Interest coverage ratio

The ratio indicates that ABC's earnings should be sufficient to enable it to pay the interest expense.

Total-debt-to-total-assets is a leverage ratio that defines the total amount of debt relative to assets
owned by a company. Using this metric, analysts can compare one company's leverage with that of
other companies in the same industry. This information can reflect how financially stable a company is.
The higher the ratio, the higher the degree of leverage (DoL) and, consequently, the higher the risk of
investing in that company.

Debt-to-Asset Ratio=

Total Assets 2

Short-Term Debt+Long-Term Debt 1

the total assets are $226,365 and that the total debt is $50,000. Therefore, the debt to asset ratio is
calculated as follows:

Debt to Asset Ratio = $50,000 / $226,376 = 0.2208 = 22%

Therefore, the figure indicates that 22% of the company’s assets are funded via debt.

The shareholder equity ratio indicates how much of a company's assets have been generated by issuing
equity shares rather than by taking on debt. The lower the ratio result, the more debt a company has
used to pay for its assets. It also shows how much shareholders might receive in the event that the
company is forced into liquidation.

Shareholer's equity ratio = Shareholder's equity / total assets

it has total assets of $3.0 million, total liabilities of $750,000, and total shareholders' equity of $2.25
million. Calculate the ratio as follows:

Shareholders' equity ratio = $2,250,000 / 3,000,000 = .75, or 75%

The debt-to-equity (D/E) ratio is used to evaluate a company's financial leverage and is calculated by
dividing a company’s total liabilities by its shareholder equity.

The D/E ratio is an important metric used in corporate finance. It is a measure of the degree to which a
company is financing its operations through debt versus wholly owned funds. More specifically, it
reflects the ability of shareholder equity to cover all outstanding debts in the event of a business
downturn. The debt-to-equity ratio is a particular type of gearing ratio.

Debt/Equity=

Total Shareholders’ Equity

Total Liabilities

At the end of 2017, Apache Corporation (APA) had total liabilities of $13.1 billion, total shareholder
equity of $8.79 billion

Profitability ratios are a class of financial metrics that are used to assess a business's ability to generate
earnings relative to its revenue, operating costs, balance sheet assets, or shareholders' equity over time,
using data from a specific point in time.

Profit margin is one of the commonly used profitability ratios to gauge the degree to which a company
or a business activity makes money. It represents what percentage of sales has turned into profits.
Simply put, the percentage figure indicates how many cents of profit the business has generated for
each dollar of sale.

Gross profit margin is a metric analysts use to assess a company's financial health by calculating the
amount of money left over from product sales after subtracting the cost of goods sold (COGS).
Sometimes referred to as the gross margin ratio, gross profit margin is frequently expressed as a
percentage of sales.

Return on assets is a profitability ratio that provides how much profit a company is able to generate
from its assets. In other words, return on assets (ROA) measures how efficient a company's
management is in generating earnings from their economic resources or assets on their balance sheet.
Return on equity (ROE) is a measure of financial performance calculated by dividing net income by
shareholders' equity. Because shareholders' equity is equal to a company’s assets minus its debt, ROE is
considered the return on net assets. ROE is considered a gauge of a corporation's profitability and how
efficient it is in generating profits.

The efficiency ratio is typically used to analyze how well a company uses its assets and liabilities
internally. An efficiency ratio can calculate the turnover of receivables, the repayment of liabilities, the
quantity and usage of equity, and the general use of inventory and machinery. This ratio can also be
used to track and analyze the performance of commercial and investment banks.

Accounts receivable turnover is the number of times per year that a business collects its average
accounts receivable. The ratio is used to evaluate the ability of a company to efficiently issue credit to its
customers and collect funds from them in a timely manner. A high turnover ratio indicates a
combination of a conservative credit policy and an aggressive collections department, as well as a
number of high-quality customers. A low turnover ratio represents an opportunity to collect excessively
old accounts receivable that are unnecessarily tying up working capital.

The inventory turnover formula measures the rate at which inventory is used over a measurement
period. It can be used to see if a business has an excessive inventory investment in comparison to its
sales, which can indicate either unexpectedly low sales or poor inventory planning.

The fixed asset turnover ratio compares net sales to net fixed assets. It is used to evaluate the ability of
management to generate sales from its investment in fixed assets.

Accounts payable turnover is a ratio that measures the speed with which a company pays its suppliers. If
the turnover ratio declines from one period to the next, this indicates that the company is paying its
suppliers more slowly, and may be an indicator of worsening financial condition.