Horizontal Common-Size Statements: 1. Horizontal Analysis A. Comparative Financial Statement Analysis B. Trend Analysis

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1.

Horizontal Analysis
a. Comparative Financial Statement Analysis
b. Trend Analysis

● Vertical common-size statements: All values in each vertical column


are expressed as a percentage of the revenue in that column. These
statements can be used to compare the income statement across two
firms or across time periods for a single firm.
● Horizontal common-size statements: All values in each row are
expressed as a ratio against the first item, which is the first-year value.
Trends in the value of these items over time are readily apparent from
the horizontal statements.

Financial statement analysis is the process an individual goes through to


analyze a company’s various financial documents in order to make an
informed decision about that business.

While the specific data contained within each financial statement will vary from
company to company, each of these documents is designed to offer insight
into the health of the company. They are also essential to monitoring a
company’s performance over time, as well as understanding how a company
is progressing toward key strategic initiatives.
At its heart, says Ittelson, financial statement analysis allows an individual to
“watch where the money, goods, and services go.”

CENGAGE
Financial Statement analysis is used to :
Predict a company’s future profitability and cash flows from its past
performance.
Evaluate the performance of a company with an eye toward identifying
problem areas.
In sum, financial statement analysis is both diagnosis-identifying where a firm has problems-
and prognosis-predicting how a firm will perform in the future.

Understand the limitations of financial statement analysis.


Financial statement analysis usually does not provide answers but only points out areas in
which more information should be gathered. We must be careful not to base a decision
solely on an analysis of financial statement numbers because:
Financial statements don’t contain all the relevant information.
Financial statements sometimes can’t be properly compared among
companies because of differences in classification, industry mix, and
accounting methods.
Most sets of financial statements will not reveal a smoking gun that, if fixed,
will solve all of a company’s problems.
Focusing on historical financial statement data may cause us to overlook
important current information.

(there are also some explanations in the book regarding the steps.)

The financial statement analysis framework consists of six formal steps:

1. State the objective and context: Determine the questions to be


answered, the presentation format, and the resources and time
available for the analysis.
2. Gather the data: Acquire the company’s financial statements and other
relevant data on its industry and the economy.
3. Process the data: Make appropriate adjustments to the financial
statements, calculate ratios, and prepare exhibits such as graphs and
common-size balance sheets.
4. Analyze and interpret the data: Use the data to answer the questions
stated in the first step and decide what conclusions or
recommendations the information supports.
5. Report the conclusions or recommendations: Prepare a report and
communicate it to the intended audience.
6. Update the analysis: Repeat these steps and update the conclusions
and recommendations periodically
7.

Need for Comparative Analysis


Every item reported in a financial statement has significance……

Comparisons can be made on a number of different bases. We will introduce three of them,
which are relevant for our discussion.

1. Intracompany basis.
a. Comparisons within a company are often useful to detect changes in financial
relationships and significant trends.
2. Industry averages.
a. Comparisons with industry averages provide information about a company’s
relative position within the industry.
3. Intercompany basis.
a. Comparison with other companies provide insight into a company’s
competitive position.
Tools of Analysis
We use various tools to evaluate the significance of financial statement data. Three
commonly used tools are as follows:
a. Horizontal Analysis
b. Vertical Analysis
c. Ratio Analysis

(In this unit, we are going to discuss or delve into the Horizontal and the vertical analysis)

Based on the bases we have discussed a while ago, HOrizontal analysis is used primarily in
intracompany comparisons. Vertical analysis is used both intra and intercompany
comparisons.

Vertical and Horizontal Analysis

Vertical and horizontal analysis are two related, but different, techniques used
to analyze financial statements. They each refer to the way in which a
financial statement is read, and the comparisons that an analyst can draw
from that reading. Both types of analysis are critical to gaining an accurate
understanding of the information provided in a financial statement.
HORIZONTAL ANALYSIS (also called Trend Anlalysis in some sources)
- Is a technique for evaluating a series of financial statement data for a single period
across different categories or accounts, typically by expressing each item as
percentage of a base amount, such as comparing financial statements from one year
to the next, to evaluate changes or shifts within a shorter time frame…. Its purpose
is to determine the increase or decrease that has taken place within that certain
period.. This change may be expressed as either an amount or a percentage.

Comparative Financial Statement Analysis

Percentage of change =
Coca-Cola Company Illustrative Example:

hows that net sales increased by $4,129,000,000, or 13.3 percent. Cost of goods sold had a
corresponding increase of $1,605,000,000, or 14.5 percent. The increase in net sales and related
increase in cost of goods sold resulted in an increase in gross margin of $2,524,000,000, or 12.7
percent. The increase in selling and administrative expenses of $1,800,000,000, or 15.8 percent,
outpaced the increase in net sales, resulting in a relatively small increase in operating income of
Question: What does the balance sheet trend analysis in Figure 13.2 "Balance Sheet Trend Analysis

for " tell us about current assets and current liabilities for Coca-Cola?

Answer: Figure 13.2 "Balance Sheet Trend Analysis for " shows that cash and cash equivalents

increased by $2,048,000,000, or 22.4 percent. Coca-Cola’s statement of cash flows would provide

detailed information regarding this increase. (Chapter 12 "How Is the Statement of Cash Flows

Prepared and Used?" covers the statement of cash flows.) Marketable securities increased 122.6

percent, accounts receivable increased 17.9 percent, and merchandise inventory increased 12.6

percent. Other current assets increased 42.0 percent.

Moving to current liabilities, accounts payable and accrued liabilities increased by 33.1 percent, loans

and notes payable increased 20.0 percent, and other current liabilities decreased 391.7 percent

(mostly attributable to a significant increase in the current portion of long-term debt).

$218,000,000, or 2.6 percent. The significant increase in other income (expenses), net of 555.6
percent relates to a one-time gain of $4,978,000,000 resulting from Coca-Cola’s acquisition of
Coca-Cola Enterprises, Inc., in 2010 (this information comes from the notes to the financial
statements). This one-time gain caused an unusually large increase in net income for 2010. This
is important as we continue our analysis of Coca-Cola Company throughout the chapter. Net
income will appear to have an unusually large increase as we cover various measures of
performance, but keep in mind that the one-time gain in 2010 of $4,978,000,000 caused most of
the increase from 2009 to 2010.

2010 2009 Amount Percent


Change
Net Sales $35,119 $30,990 ? ?

Cost of goods sold 12,693 11,088 ? ?

Gross Margin $22,426 $19,902 ? ?

- percentage relationships.

To provide a reference point for comparing subsequent periods, and also to identify if how much
increases or decreases occurred in subsequent years.

Trend percentage = Current Year / Base Year


Questions:
1. It is the process an individual goes through to analyze a company’s various financial
documents in order to make an informed decision about that business.
2. The last step when conducting a Financial Statement Analysis is Gathering of Data.
3. (Identify the Formula given if it is a Horizontal Analysis or Vertical Analysis)
4. Provide the correct answers in the missing trend percentages below.

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