STRATEGIC BUSINESS ANALYSIS (SBA)

SBA 01: Financial Statement Analysis

Horizontal & Vertical Analysis
Prepared by: R. Pascual

CPALE SYLLABUS COVERED

2.0 Financial Management
2.2 Financial Management Concepts and Techniques for Planning, Control & Decision Making
2.2.1 Financial Statement Analysis
2.2.1.1 Vertical Analysis (common-size financial statements)
2.2.1.2 Horizontal Analysis (trend percentages and index analysis)
2.2.1.3 Cash Flow Analysis (interpretation of cash flows including free cash flow concept)
2.2.1.4 Gross Profit Variance Analysis (price, cost and volume factors)
2.2.1.5 Financial ratios (liquidity, solvency, activity, profitability, growth and other ratios; Du Pont Model)
2.2.1.6 Financial forecasting using additional funds needed (AFN)

2.2.1 Financial Statement Analysis

FS ANALYSIS - involves the assessment and evaluation of the firm’s past performance, its present condition, and future
business potentials. The analysis provides information about the following, among others:

1. Profitability of the business firm

2. Ability to meet company obligations
3. Safety of investment in the business
4. Effectiveness of management in running the firm
5. Over-all company marketability

2.2.1.1 Vertical Analysis (common-size financial statements)

VERTICAL (COMMON-SIZE) ANALYSIS

Vertical analysis is the process of comparing figures in the financial statements of a single period. It involves
conversion of figures in the statements to a common base. This is accomplished by expressing all figures in the statements
as percentages of an important item such as total assets (in the balance sheet) or net sales (in the income statement).
These converted statements are called common-size statements or percentage composition statements.

CONVERSION PROCEDURES

• Line items on the balance sheet are generally expressed as a percentage of total assets
• Line items on the income statement are generally expressed as a percentage of net sales.

By expressing the financial data in percentage using a particular base, the size of different companies is brought to an
ordinary expression. Size alone does not reflect the true merits of managerial performance. To compare the financial data,
they should be put in equal standing by expressing financial figures into percentage and defining an ordinary base (100%).

Percentage composition statements are used for comparing:

1. Multiple years of data from the same firm

2. Companies that are different in size
3. Company to industry averages

DECISION TOOLKIT

DECISION INFO NEEDED FOR

CHECKPOINTS DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

Comparative financial
statements should be prepared
over at last two years, with the
How did the first year being reported as the
company's financial base year. Significant changes should be
Income Statement &
position and operating investigated to determine the
Balance Sheet
results with those of the reason for the change.
previous period? Changes in each line item
relative to the base year should
be presented both by amount
and by percentage. This is called
horizontal analysis.

2.2.1.2 Horizontal Analysis (trend percentages and index analysis)

HORIZONTAL ANALYSIS (INCRESE/DECREASE METHOD)

Horizontal or index analysis involves comparison of figures shown in the financial statements of two or more
consecutive periods. Horizontal analysis is also called “inter-period” “cross-period”, or intercompany analysis. The difference
of the amount between two periods is calculated, and the percentage change from one period to the next is computed using
the earlier period as the base.
 Horizontal analysis enables investors and analysts to see what has been driving a company’s financial performance
over time, as well as identify trends and growth patterns. The statements for two or more periods are used in horizontal
analysis. The study of percentage changes in comparative statements is called horizontal analysis. It is computed as:

Most Recent Value − Base Period Value

Percentage Change (∆ %) =
Base Period Value
or

Amount of Change
Percentage Change (∆ %) =
Base

Comparisons can be made between an actual amount compared against a budgeted amount, with the budget
serving as the base or pattern or performance. Such comparisons may be made between two time periods such as in years,
quarters, months etc. or between actual and budget data and other bases of analysis. When an enterprise’s data are
compared with a data of another enterprise operating in a different industry, such process is called as “cross-sectional
analysis”. The difference could either be an increase or decrease both in amount or in percentage.

The base may be the last year’s data, budgeted data, average industry data, or chief competitor’s data. Getting the
changes in amount and in percentage is not the end-view of financial statement analysis. The interpretation is of more
relevance.

LIMITATION: If a negative or a zero amount appears in the base year, percentage change cannot be computed.

The percentage change is not computed if the denominator is ZERO or NEGATIVE. If the base is zero, the percentage
change cannot be computed. IF the base is negative, the percentage of change does not reflect the true nature of the
change, hence the percentage change does not reflect the true nature of the change, hence, the percentage of change is
not determined.

TREND ANALYSIS

Horizontal analysis normally applied to a two-year analysis. Trend analysis extends beyond two years. The purpose
of trend analysis is to track down what happened in the past and provide a pattern on what may happen in the coming
years. Trend analysis uses indexes and ratios to simplify the visible complication of numbers contained in the financial
reports. Financial data expressed in indexes and ratios are easily readable than those presented in terms of millions of
pesos.

Trend percentages are index numbers showing relative changes in financial data resulting with the passage of time.
Trend percentages state several years’ financial data in terms of a base year.

Indexes are expressed in hundreds whole ratios are expressed in normal decimal places. In computing the trend
index or ratio, the base year (100%) is normally the earliest year. The choice of the base year is, however, purely judgmental.

DECISION TOOLKIT

DECISION INFO NEEDED FOR

CHECKPOINTS DECISION TOOL TO USE FOR DECISION HOW TO EVALUATE RESULTS

Each line item on the income

statement should be presented
as a percentage of net sales,
and each line item on the
How do the balance sheet should be
relationships between presented as a percentage of Any significant differences either
items in this year’s total assets or total liabilities across years or between
Income Statement & and stockholders’ equity
financial statements companies should be
Balance Sheet
compare with those of investigated to determine the
last year or those of cause.
competitors?
These percentages should be
investigated for differences either
across years in the same
company or in the same year
across different companies. This
is called vertical analysis
 EXERCISES: FS ANALYSIS – HORIZONTAL & VERTICAL ANALYSIS

1. Horizontal and Vertical Analysis – Statement of Financial Position. The financial position of Wee Company at the end
of 202 and 2022 is as follows (in thousands)

2022 2021
Assets
Cash and cash equivalents 6,000 10,000
Trade and other receivables 80,000 50,000
Inventory 54,000 60,000
Investment property 30,000 -
Property, plant and equipment (net) 200,000 150,000
Intangible assets 20,000 20,000
Other non-current assets 10,000 40,000
Total assets 400,000 330,000

Liabilities
Current Liabilities 60,000 94,000
Long-term liabilities 176,000 148,000
Total liabilities 236,000 242,000

Shareholder's Equity
8% Preference equity 20,000 18,000
Ordinary equity 108,000 84,000
Share premium 10,000 10,000
Retained Earnings 26,000 (24,000)
Total shareholders' equity 164,000 88,000
Total liabilities and shareholders' equity 400,000 330,000
Required:

a. Prepare a comparative statement of financial position showing peso and percentage changes for 2022 as compared
with 2021.
b. Prepare an ordinary-size statement of financial position as of December 31, 2021 and 2022.
c. Based on your data derived in requirements 1 and 2, comment on the financial position of Wee Company as of
December 31, 2022

2. Comparative and Common-size analysis – Statement of Comprehensive Income. The operating activities of Tiny
Company for the year ended December 31, 2022 and 2021 are summarized below:

2021 2022
Sales 906,400 1,008,000
Sales returns 26,400 48,000
Net Sales 880,000 960,000
Cost of goods sold 484,000 720,000
Selling and general expenses 237,600 192,000
Interest expenses 61,600 67,200
Profit (loss) before income tax 96,800 (19,200)
Income tax (refund) 38,720 (7,680)
Profit (loss) 58,080 (11,520)
Required:

a. Prepare a comparative statement of comprehensive income showing the peso changes and percentage for 2022
and as compared with 2021.
b. Prepare a comparative statement of comprehensive income showing a percentage analysis of component revenue
and expense items of net sales for each year.
c. Based on the above percentages, comment on Tiny’s results of operations for 2022.

3. Trend ratios. Zip Corporation’s sales, current assets and current liabilities have neem reported as follows over the last
five years (amounts in thousands)

2022 2021 2020 2019 2018

Sales 21,600 19,200 18,400 17,280 16,000
Current Assets 5,252 4,362 4,440 4,534 4,450
Current Liabilities 950 900 700 650 500

Required: Express all the sales, current assets, and current liabilities on trend index. Round your decimals up to 2 places.
4. In 2022, Ligaya Company’s net income was P200,000 and in 2023, it was P50,000. What percentage increase in net
income must Ligaya achieve in 2024 to offset the 2023 decline in net income?

a. 60%
b. 300%
c. 400%
d. 600%

5. Last year, a business had no long-term investments; this year long term investments amount to P100,000. In horizontal
analysis, the change in long-term investments should be expressed as

a. An absolute amount of P100,000 and an increase of 100%

b. An absolute amount of P100,000 and an increase of 1,000%
c. An absolute amount of P100,000 and no value of percentage change
d. No change in any items because there was no investment in the previous year.

6. The type of analysis that is concerned with the relationships among the components of financial statements is to prepare
a

a. Ratio analysis
b. Trend analysis
c. Vertical analysis
d. Profitability analysis

7. In a single-period common-size income statement, the base amount (100%) is normally the

a. Gross sales
b. Net sales
c. Net cash sales
d. Net credit sales

8. In financial statement analysis, expressing all financial statement items as a percentage of base-year amounts is called

a. Horizontal analysis
b. Vertical analysis
c. Ratio analysis
d. Cash flow analysis

9. On a common-size balance sheet, what would represent 100%

a. Total assets
b. Total liabilities
c. Total current assets
d. Total stockholders’ equity

10. In horizontal analysis, each item is expressed as a percentage of the

a. Base year figure

b. Total assets figure
c. Net income figure
d. Retained earnings figure

- END of SBA 01 –