This chapter discusses several common methods
of analyzing and relating the data in financial statements and, as
a result, gaining a clear picture of the solvency and profitability
of a company. Internally, management analyzes a company’s financial
statements as do external investors, creditors, and regulatory
agencies. Although these users have different immediate goals,
their overall objective in financial statement analysis is the
same—to make predictions about an organization as an aid in
decision making.
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Objectives of financial statement
analysis
Management’s analysis of financial
statements primarily relates to parts of the company. Using this
approach, management can plan, evaluate, and control operations
within the company. Management obtains any information it wants
about the company’s operations by requesting special-purpose
reports. It uses this information to make difficult decisions, such
as which employees to lay off and when to expand operations. Our
primary focus in this chapter, however, is not on the special
reports accountants prepare for management. Rather, it is on the
information needs of persons outside the firm.
Investors, creditors, and regulatory
agencies generally focus their analysis of financial statements on
the company as a whole. Since they cannot request special-purpose
reports, external users must rely on the general-purpose financial
statements that companies publish. These statements include a
balance sheet, an income statement, a statement of stockholders’
equity, a statement of cash flows, and the explanatory notes that
accompany the financial statements.
Financial statement analysis consists
of applying analytical tools and techniques to financial statements
and other relevant data to obtain useful information. This
information reveals significant relationships between data and
trends in those data that assess the company’s past performance and
current financial position. The information shows the results or
consequences of prior management decisions. In addition, analysts
use the information to make predictions that may have a direct
effect on decisions made by users of financial statements.
Comparative financial
statements present the same company’s financial
statements for one or two successive periods in side-by-side
columns. The calculation of dollar changes or percentage changes in
the statement items or totals is horizontal analysis. This
analysis detects changes in a company’s performance and highlights
trends.
The good news is you have already been performing
the first part of horizontal analysis without realizing it when you
were preparing the statement of cash flows. Horizontal analysis
consists of 2 things:
- Dollar amount of change (calculated as Current Year amount –
Previous Year amount)
- Percentage of change (calculated as Dollar amount of change /
previous year amount)
Horizontal analysis is called horizontal because
we look at one account at a time across time. We can perform this
type of analysis on the balance sheet or the income statement.
Let’s look at this video followed by another example.
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The comparative financial statements of Synotech,
Inc., will serve as a basis for an example of horizontal analysis
and vertical analysis of a balance sheet and a statement of income
and retained earnings. Recall that horizontal analysis calculates
changes in comparative statement items or totals. Here is an
example of Synotech, Inc. current asset section (in millions) of
the balance sheet with horizontal analysis performed:
|
2015 |
2014 |
Increase (or
Decrease) |
Percent of
Change |
Current assets: |
|
|
|
|
Cash |
$ 298.00 |
$ 250.50 |
$ 47.50 |
19.0% |
Marketable securities |
71.30 |
57.50 |
$ 13.80 |
24.0% |
Receivables, net |
1,277.30 |
1,340.30 |
$ (63.00) |
-4.7% |
Inventories |
924.80 |
929.80 |
$ (5.00) |
-0.5% |
Other current assets |
275.30 |
254.30 |
$ 21.00 |
8.3% |
Total current assets |
$ 2,846.70 |
$ 2,832.40 |
$ 14.30 |
0.5% |
What does this tell us? Notice total current
assets have increased $ 14.3 million, consisting largely of
increases in cash, marketable securities, and other current assets
despite a $63.0 million decrease in net receivables.
Next, study Column (4), which
expresses as a percentage the dollar change in Column (3).
Frequently, these percentage increases are more informative than
absolute amounts, as illustrated by the current asset changes. The
percentages reveal that current assets increased .5% which if we
compared this to current liabilities would give us an idea if the
company could pay their debt in the future.
Studying the percentages on the
balance sheet could lead to several other observations. For
instance, if there was a 6.9% decrease in long-term debt indicates
that interest charges will be lower in the future, having a
positive effect on future net income. An increase in retained
earnings could be a sign of increased dividends in the future; in
addition, the increase in cash of 19% could support this
conclusion.
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- Accounting Principles: A Business Perspective. Authored
by: James Don Edwards, University of Georgia & Roger
H. Hermanson, Georgia State University. Provided
by: Endeavour International Corporation.
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- What is Financial Statement Analysis? - Accounting Video.
Authored by: Brian Routh TheAccountingDr.
Located at: youtu.be/8DmChanpSmw.
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- What is Financial Statement Analysis: Horizontal Analysis? -
Accounting video . Authored by: Brian Routh
TheAccountingDr. Located at: youtu.be/x_ltrzpz4Ew.
License: All Rights Reserved.
License Terms: Standard YouTube License