FREE online courses on Financial Ratio Analysis - Comparing Financial
Statements
Financial Statements
One final way of evaluating financial performance is to
simply compare financial statements from period to period and to compare
financial statements with other companies. This can be facilitated by vertical
and horizontal analysis.
Vertical analysis compares line items on a financial
statement over an extended period of time. This helps us spot trends and restate
financial statements to a common size for quick analysis. For the Balance Sheet,
we will use total assets as our base (100%) and for the Income Statement, we
will use Sales as our base (100%). We will compare different line items on the
financial statements to these bases and express the line items as a percentage
of the base.
EXAMPLE - Income
Statements for the last three years are summarized below:
1990
1991 1992
Sales
$ 300,000 $
310,000 $ 330,000
Cost of Goods Sold
(110,000) (105,000) (110,000)
G & A Expenses
( 80,000)
(100,000)
(105,000)
Net Income
$ 110,000 $
105,000 $ 115,000
< - - - - - - - Vertical Analysis - - - - - - - - - >
Sales 100% 100% 100%
Cost of Goods Sold
37% 34% 33%
G & A Expenses
27% 32% 32%
Net Income 37% 34% 35%
By expressing balances as percentages, we can easily notice
that G & A Expenses are trending up while Cost of Goods Sold is moving down.
This may require further analysis to determine what is behind these trends.
Horizontal analysis looks at the percentage change in a line
item from one period to the next. This helps us identify trends from the
financial statements. Once we spot a trend, we can dig deeper and investigate
why the change occurred. The percentage change is calculated as:
(Dollar Amount in Year 2 - Dollar Amount in Year 1) / Dollar
Amount in Year 1
EXAMPLE - Sales
were $ 310,000 in 1991 and $ 330,000 in 1992. The percentage change in sales is:
($ 330,000 - $ 310,000) / $ 310,000 = 6.5%
We can apply this analysis "horizontally" down the financial
statement for the year 1992:
Sales
6.5%
Cost of Goods Sold 4.8%
G & A Expenses 5.0%
Net Income
9.5%
