Fundamentals of

Accountancy,
Business and Management
 Analysis and
Interpretation of
Financial Statement 1
Learning Competency

• Perform vertical and horizontal analyses of financial

statements of a single proprietorship.
Financial Statement Analysis

Financial statements inform the readers of a company's financial position, results

or operations, cash flows and changes in equity. However, these information are not
sufficient to help readers make decisions about the business. Let us look at the
succeeding scenario to understand this point. For example, two companies asked you
to invest in them as part Owner. However, you can only afford to give money to one
company. We want to know which of the two companies (Company A or Company
B) is the better choice. Both of them are in the same industry. Company A and
Company B generated net income in the past year of P1,000,000 and P900,000,
respectively. Looking at the Statement of Financial Position (SFP), you found out
that Company A and Company B has reported total assets of P10,000,000 and
P8,000,000, respectively. Based on these information, which company will you
choose? Will it be Company A because the company reported higher assets and net
income?
 As future investors, you should be interested in the return
on your investment. You want to have an indication which of
the two companies can give better returns for your money.
You may also be interested in the stability of returns.
However, it is not enough to know total assets and reported
net income in order to address your concerns. This means that
reading the financial statement is inadequate. We need tools or
techniques that we can use on the financial statement numbers
in order to have a better understanding of the business.
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 (White et.al 1998).

There are three kinds of FS analysis techniques:

- Horizontal analysis
- Vertical analysis
- Financial ratios
Horizontal analysis also called trend analysis, is a technique for
evaluating a series of financial statement data over a period of
time to determine the increase or decrease that has taken place
(Weygandtet.al 2013). 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:

2014 2013

Sales P 250,000 P 175,000

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

✓Percentage change = (P250,000 - P175,000) / P175,000 = 42.86%
✓ Sales increased by P75,000. This represents a growth of 42.86% from
2013.
Vertical analysis also called common-size analysis, is a technique
that expresses each financial statement item as a percentage of a base
amount (Weygandt et.al. 2013).

- 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:
- 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
PRACTICE EXERCISES: Prepare a horizontal & vertical analysis
for
C & F Store’s SFP & SCI.
ASSIGNMENT:
A. Prepare a common-size Statement of Comprehensive Income for 2014
and 2013 for Abakada Trading Company
B. Prepare a horizontal analysis for Abakada Trading Company