ANALYSIS OF PAST AND

PRESENT PERFORMANCE
Financial Analysis and Reporting Lesson 2
OBJECTIVES

At the end of this lesson, the students are expected to:

 1. Explain what we can learn by analyzing a firm’s financial
statements
 2. Be able to conduct financial analysis using Vertical Analysis,
Horizontal analysis and Trend Analysis
 3. Identify the proper situations to use specific analysis techniques
 This type of analysis is commonly used in analyzing and
comparing historical data such as financial ratios or line items
(accounts) over a number of accounting period.
 Horizontal analysis can be appreciated by use of absolute
comparison or percentage comparison using the previous or
historical period as baseline year. This kind of analysis is also
called base-year analysis.

HORIZONTAL ANALYSIS
 Horizontal analysis is used in the review of a company's financial
statements over multiple periods.
 It is usually depicted as a percentage growth over the same line item in the
base year.
 Horizontal analysis allows financial statement users to easily spot trends
and growth patterns.
 It can be manipulated to make the current period look better if specific
historical periods of poor performance are chosen as a comparison.

HORIZONTAL ANALYSIS
HOW TO PERFORM A HORIZONTAL
ANALYSIS?
THREE PRIMARY STEPS:
1. GATHER FINANCIAL INFORMATION
2. DETERMINE COMPARISON METHODS
3. IDENTIFY TRENDS AND PATTERNS
1.GATHER FINANCIAL INFORMATION
To perform a horizontal analysis, you must first gather financial
information of a single entity across periods of time. Most horizontal
analysis entail pulling quarterly or annual financial statements,
though specific account balances can be pulled if you're looking for
a specific type of analysis.
Be mindful that the gaps between each financial statement are
consistent. You can choose whatever interval (month-over-month,
year-over-year, etc.), but each iterative financial statement should be
equal distance away regarding when it was issued compared to
other bits of financial information.
2. DETERMINE COMPARISON METHODS

With the financial information in hand, it's time to

decide how to analyze the information. There are
several primary comparison methods.
2. DETERMINE COMPARISON METHODS

First, a direction comparison simply looks at the results from

one period and comparing it to another.
For example, the total company-wide revenue last quarter
might have been 75 million pesos, while the total company-
wide revenue this quarter might be 85 million pesos. This
type of comparison is most often used to spot high-level,
easily identifiable differences.
2. DETERMINE COMPARISON METHODS

Second, a variance analysis determines not only the dollar (or peso)
amount but the direction of change for a given general ledger
account.
As opposed to simply identifying the difference between two
numbers, variance analysis strives to determine the company's
financial health by identifying directional changes, frequency of
directions, or how each financial result compared against an
internal target (i.e. a budget).
2. DETERMINE COMPARISON METHODS

Last, a horizontal analysis can encompass calculating

percentage changes from one period to the next. As a
company grows, it often becomes more difficult to sustain
the same rate of growth, even if the company grows in pure
dollar size. This percentage method is most useful when
identifying changes over a longer period of time where there
may be significant deviations from the base period to the
current period.
3. IDENTIFY TRENDS AND PATTERNS

With different bits of calculated information now embedded

into the financial statements, it's time to analyze the results.
The identification of trends and patterns is driven by asking
specific, guided questions.
For example, upper management may ask "how well did each
geographical region manage COGS over the past four quarters?".
This type of question guides itself to selecting certain horizontal
analysis methods and specific trends or patterns to seek out.
EXAMPLE OF HORIZONTAL ANALYSIS
Horizontal analysis typically shows the changes from the
base period in currency and percentage.
For example, a statement that says revenues have increased
by 10% this past quarter is based on horizontal analysis. The
percentage change is calculated by first dividing the change
in currency between the comparison year and the base year
by the line item value in the base year, then multiplying the
quotient by 100.
EXAMPLE OF HORIZONTAL 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.
EXAMPLE OF HORIZONTAL ANALYSIS
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).
WHAT ARE THE BENEFITS OF
HORIZONTAL ANALYSIS?
Horizontal analysis is valuable because analysts assess past performance
along with the company’s current financial position or growth.
(Performance of firm between periods) Trends emerge, and these can be used
to project future performance. Horizontal analysis can also be used to
benchmark a company with competitors in the same industry.
Investors can use horizontal analysis to determine the trends in a company's
financial position and performance over time to determine whether they want
to invest in that company. However, investors should combine horizontal
analysis with vertical analysis and other techniques to get a true picture of a
company's financial health and trajectory.
WHEN CAN WE USE HORIZONTAL
ANALYSIS?
Horizontal analysis is most useful when an entity
has been established, has strong record-keeping
capabilities, and has traceable bits of historical
information that can be dug into for more
information as needed. This type of analysis is
more specific relevant for analyzing the value we
maybe selling or acquiring.
VERTICAL ANALYSIS
 Vertical analysis is also known as Common Size Financial Statement.
A common size financial statement is a standardized version of a financial
statement in which all entries are presented in percentages.
 It helps compare a firm’s financial statements with those of other firms
even if the other firms are not of equal size.(FIRM vs FIRM)
How to prepare a common size financial statement?
 For a common size income statement, divide each entry in the income
statement by sales.
 For a common size balance sheet, divide each entry in the balance sheet by
total assets.
WHAT IS THE DIFFERENCE BETWEEN
HORIZONTAL ANALYSIS AND VERTICAL
ANALYSIS?
The primary difference between vertical analysis and
horizontal analysis is that vertical analysis is focused
on the relationships between the numbers in a single
reporting period, or one moment in time. Horizontal
analysis looks at certain line items, ratios, or factors
over several periods to determine the extent of
changes and their trends.
VERTICAL ANALYSIS
Vertical analysis is a method of financial statement analysis
in which each line item is listed as a percentage of a base
figure within the statement. Thus, line items on an income
statement can be stated as a percentage of gross sales, while
line items on a balance sheet can be stated as a percentage
of total assets or total liabilities, and vertical analysis of a
cash flow statement shows each cash inflow or outflow as a
percentage of the total cash inflows.
VERTICAL ANALYSIS
 Vertical analysis makes it much easier to compare the
financial statements of one company with another, and
across industries. This is because one can see the relative
proportions of account balances. It also makes it easier to
compare previous periods for time series analysis, in which
quarterly and annual figures are compared over a number
of years, in order to gain a picture of whether performance
metrics are improving or deteriorating.
VERTICAL ANALYSIS
 For example, by showing the various expense line items in the income
statement as a percentage of sales, one can see how these are
contributing to profit margins and whether profitability is improving
over time. It thus becomes easier to compare the profitability of a
company with its peers.
 Financial statements that include vertical analysis clearly show line
item percentages in a separate column. These types of financial
statements, including detailed vertical analysis, are also known as
common-size financial statements and are used by many companies to
provide greater detail on a company’s financial position.
EXAMPLE OF VERTICAL ANALYSIS
 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:

REMEMBER: For a common size income statement, divide each

entry in the income statement by sales.
EXAMPLE OF VERTICAL ANALYSIS
ANALYSIS
 Cost of goods sold make up 20% of the firm’s sales
resulting in a gross profit of 80%
 SELLING EXPENSE ACCOUNT for about ________
% of sales.
 Income taxes account for ______% of the firm’s sales.
 After all expenses, the firm generates net income of
__________ % of firm’s sales.
VERTICAL ANALYSIS FORMULA
 The formula for vertical analysis is straightforward. You simply divide
the figure for a specific line item by the total assets (for a balance sheet)
or total sales (for an income statement) and then multiply the result by
100 to get a percentage. This formula can be expressed as:
 Vertical Analysis Percentage = (Individual Line Item / Total Assets or
Total Sales) * 100
 Converting the raw numbers into percentages provides a clearer picture
of the proportion of the asset or liability in the context of the company’s
total financial resources.
EXAMPLE
 Say Jackson Widget Company’s
balance sheet shows the following
amounts as of December 31, 2023:
• Cash: $100,000
• Accounts Receivable: $40,000
• Fixed Assets: $50,000
• Accounts Payable: $30,000
• Notes Payable: $10,000
• Capital Stock: $10,000
• Retained Earnings: $140,000
 Based on the information above,
Jackson Widget Company’s total
assets are $190,000. That’s $100,000
in cash plus $40,000 in accounts
receivable plus $50,000 of fixed
assets.
 So a vertical analysis would show
Cash as 53% of total assets
($100,000 / $190,000) * 100 =
52.63%), accounts receivable as 21%
of total assets ($40,000 / $190,000) *
100 = 21.05%), and so on.
HOW TO PERFORM A VERTICAL ANALYSIS ON YOUR
BALANCE SHEET
 Performing a vertical analysis on your balance sheet is a
strategic way to gain valuable insights about your business’s
financial standing. By converting each line item into a
percentage of total assets, you can uncover patterns, identify
areas of strength and weakness, and make informed decisions
about your company’s future. Here is a step-by-step guide on
how to perform a vertical analysis on your balance sheet:
STEP 1: GATHER YOUR BALANCE SHEET
FIGURES
 First,gather the balance sheet figures for each
line item, such as cash, accounts receivable,
fixed assets, etc. You can likely export the
company’s financial statements from your
accounting software to an Excel spreadsheet
for easy analysis.
STEP 2: IDENTIFY TOTAL ASSETS
 Thenext step is to find the Total
Assets figure on your balance sheet.
This primary variant serves as the
base figure for your vertical
analysis.
STEP 3: CALCULATE THE
PERCENTAGE FOR EACH LINE ITEM

 For each line item on the balance sheet,

divide it by the Total Assets and multiply
the result by 100. This gives you the
percentage each line item represents of
the Total Assets.
STEP 4: INTERPRET THE
RESULTS
 Analyze the percentages to identify patterns
and trends. Look for items with a significant
percentage of Total Assets, as these could
represent areas of vulnerability or strength.
STEP 5: COMPARE WITH
INDUSTRY BENCHMARKS

 Compare your results with

industry benchmarks or similar
companies to see how your
business stacks up.
STEP 5: COMPARE WITH
INDUSTRY BENCHMARKS

 Compare your results with

industry benchmarks or similar
companies to see how your
business stacks up.
STEP 6: USE THE RESULTS FOR
DECISION-MAKING
 Usethe insights gained from the vertical
analysis in your decision-making
processes. This could influence your
budgeting, forecasting, and strategic
planning.
EXAMPLE OF VERTICAL
ANALYSIS
AGAIN, HORIZONTAL VS
VERTICAL ANALYSIS
While vertical analysis focuses on the relative size of different line items and their ratios in the
same period, horizontal analysis, on the other hand, involves studying the trends and changes
in these line items over multiple periods. In vertical analysis, each line item in the financial
statement is expressed as a percentage of a base figure in the same period (for example, the
total assets or gross sales). However, in horizontal analysis, the relative change in a line item
from one period to the next is calculated and typically presented as a percentage change.
This approach provides insights into patterns over time, highlighting increases, decreases, or
trends. For example, it can help identify if a company’s accounts receivable has steadily
increased over the past three years, which could indicate a problem with credit and collection
policies.
Both vertical and horizontal analysis methods provide valuable information/insights. When
used together, they offer a comprehensive view of the company’s financial health.
LIMITATIONS AND DRAWBACKS
OF VERTICAL ANALYSIS
Despite the benefits and insights that vertical analysis can provide, it’s essential
to acknowledge its limitations and drawbacks.
Here are a few of those constraints.
•Provides insight into a particular point in time rather than over a
period. One major limitation is that vertical analysis only provides a snapshot of
a company’s financial health at a specific point in time. This means it may not
adequately capture fluctuations that occur throughout the year.
•Financial statement errors can distort results. A useful vertical analysis
depends on having accurate financial data. Any errors or manipulations in the
figures used can distort the results.
LIMITATIONS AND DRAWBACKS
OF VERTICAL ANALYSIS
• Lacks context. Vertical analysis also falls short when it comes to providing context. While
it’s useful for comparing companies of different sizes, it doesn’t account for differences in
industries or markets. A ratio that may seem strong in one sector could be weak in another.
•Doesn’t provide a complete picture. Finally, a vertical analysis of a balance sheet doesn’t
provide any information on the company’s cash flows, gross sales or gross profit, all of which
are vital aspects of assessing a company’s financial health.
To overcome these limitations, it’s a good idea to use vertical analysis in conjunction with
other financial analysis techniques, such as horizontal analysis or ratio analysis, as well as
other financial ratios.
Vertical analysis of a balance sheet can be a powerful tool to understand your company’s
performance or how two businesses compare.
TREND ANALYSIS

 This type of analysis is commonly used in drawing/

visualizing the current and historical performance of a
company to predict the future performance.
 Trend analysis can either use $ change from previous
year (base year) to current year or absolute amount.
 Normally this analysis involves multiple period to be able
to generate a sufficient trend line.
TREND ANALYSIS SAMPLE
TREND ANALYSIS SAMPLE