Financial statement (Balance Sheet and Profit and Loss Account) are periodical reports which reflect the financial position and operating performance of the entire business for an accounting period generally one year. They provide valuable data to management, investors, shareholders, creditors, financiers and government authorities (Milbourn & Haight, 2005). Financial analysis refers to the process of systematically examining the significance of data with respect to particular items or groups of items presented in the financial statements. The main objectives of financial analysis are to gain an insight into the profitability of business operations and financial positions so as to judge whether progress is adequate or the position has improved. Broadly speaking, there is three techniques of financial analysis on the basis of data in the annual statements: (1) Horizontal Analysis , (2) Vertical Analysis , and (3) Ratio Analysis .
1. Vertical Analysis
In the Vertical analysis, each of the items in the respective financial statements is expressed as a ratio (percentage) of the total assets (In the case of Balance Sheet) and net sales (in the case of Income Statement). In the vertical analysis we assume the sales are in full volume so sales = 100% then we Covent all other items in percentage form on the basis of sales.
Vertical analysis is the financial statement in which all items of a financial statement are presented in percentages. In vertical analysis, balance sheet items and income statement items are expressed in percentage. All balance sheet accounts are presented as a percentage of the total assets and all income statement items are presented as a percentage of sales (Ott, Riddiough, & Yi, 2009). Sales is assumed to be equal to 100, for income statement and total assets is assumed to be common based equal to 100 in case of balance sheet.
For example, vertical analysis in balance sheet and income statement of Annapurna Textile Inc. using the following relation and presented below:
% of income statement items (individually) = Individual items of income statement/ Total sales *100
% of balance sheet items (individually) = Individual items of balance sheet/ Total Asserts *100
Fig (1): Vertical Analysis of financial statement of Annapurna Textile Inc. as on June 2018.
Fig (2): Vertical analysis of income statement of Annapurna Textile Inc. for the year June 2018
A closer look into vertical analysis in fig (1) shows the distribution pattern of liabilities among current liabilities, long - terms liabilities and equity capital. Similarly, it shows the distribution pattern of total asserts among current asserts, fixed assets and other asserts. For example, in assessing the liquidity position of Annapurna Textile Inc. the balance sheet reveals that its total current assets represents 33.7 percentage of the total asserts of which 9.52 percentage of total assets are in the form of investment in inventory.
The Vertical Analysis income statement Fig (2) reveals what portion of sales has been absorbed by various costs, and expenses incurred and the percentage of the total sales that remains as net income. For example, the table shows that 60 percent of total sales are incurred as cost of goods sold and only 13.54 percentage of total sales are in the form of net income to the firm.
2. Horizontal Analysis
The technique of Horizontal analysis involves preparation of comparative balance sheet and comparative income statement so as to highlight changes in the various assets, liabilities income and expenditure, and the resulting profit or loss. The changes may be expressed in absolute amounts or percentages (Smart, Megginson, & Gitman, 2007). The data may be presented for two years or for a number of successive years so as to examine the trend.
As a financial statement, balance sheet is concerned with summarizing assert owned by the firm and sources of borrowing and owned funds in acquiring these assets. Figure (3) shows a hypothetical balance sheet of Annapurna Textile Inc. as on June 2018.
Fig (3): Annapurna Textile Inc. Balance sheet on Dec 2006 (In million)
The left hand side of the balance sheet shows asserts of Annapurna Textile Inc. whereas the right hand side shows the liabilities and equity as on Dec 2006. In the above balance sheet, the assets are arrange in order of their convertibility into cash and liabilities and equity are arranged in order of their maturity. But, they can be ordered in reverse order. The proper interpretation of financial statement requires a clear and correct understanding of the basic divisions of balance sheet.
Finally, this technique involves preparation of Comparative Balance Sheet and Comparative Income Statement so as to highlight the changes in the various assets, liabilities, income and expenditure. In the Comparative Balance Sheet, the figures (3) of assets and liabilities are set out as at the beginning and at the June of the year along with the extent of increases or decreases between the two dates.
The Comparative Income Statement is drawn on the same principle as the Horizontal Balance Sheet. The statement is prepared in a vertical form. There are columns, as in a comparative balance sheet, to show the amount of income and expenditure for two years in (2005 and 2006) or more along with the increase or decrease in amounts as also percentage increases or decreases. The percentages reflects the changes that have occurred over successive periods. Unusual changes can thus be detected and their causes determined.
References
Milbourn, G., & Haight, T. (2005). Providing students with an overview of financial statements using the Dupont analysis approach. Journal of American Academy of Business, 6(1) , 46-50.
Ott, S., Riddiough, T., & Yi, H. (2009). Finance, investment and investment performance: Evidence from the REIT sector. Real Estate Economics, 33(1) , 203-207.
Smart, S., Megginson, W., & Gitman, L. (2007). Corporate Finance.
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Financial statement (Balance Sheet and Profit and Loss Account) are periodical reports which reflect the financial position and operating performance of the entire business for an accounting period generally one year. They provide valuable data to management, investors, shareholders, creditors, financiers and government authorities (Milbourn & Haight, 2005). Financial analysis refers to the process of systematically examining the significance of data with respect to particular items or groups of items presented in the financial statements. The main objectives of financial analysis are to gain an insight into the profitability of business operations and financial positions so as to judge whether progress is adequate or the position has improved. Broadly speaking, there is three techniques of financial analysis on the basis of data in the annual statements: (1) Horizontal Analysis , (2) Vertical Analysis , and (3) Ratio Analysis .
1. Vertical Analysis
In the Vertical analysis, each of the items in the respective financial statements is expressed as a ratio (percentage) of the total assets (In the case of Balance Sheet) and net sales (in the case of Income Statement). In the vertical analysis we assume the sales are in full volume so sales = 100% then we Covent all other items in percentage form on the basis of sales.
Vertical analysis is the financial statement in which all items of a financial statement are presented in percentages. In vertical analysis, balance sheet items and income statement items are expressed in percentage. All balance sheet accounts are presented as a percentage of the total assets and all income statement items are presented as a percentage of sales (Ott, Riddiough, & Yi, 2009). Sales is assumed to be equal to 100, for income statement and total assets is assumed to be common based equal to 100 in case of balance sheet.
For example, vertical analysis in balance sheet and income statement of Annapurna Textile Inc. using the following relation and presented below:
% of income statement items (individually) = Individual items of income statement/ Total sales *100
% of balance sheet items (individually) = Individual items of balance sheet/ Total Asserts *100
Fig (1): Vertical Analysis of financial statement of Annapurna Textile Inc. as on June 2018.
Fig (2): Vertical analysis of income statement of Annapurna Textile Inc. for the year June 2018
A closer look into vertical analysis in fig (1) shows the distribution pattern of liabilities among current liabilities, long - terms liabilities and equity capital. Similarly, it shows the distribution pattern of total asserts among current asserts, fixed assets and other asserts. For example, in assessing the liquidity position of Annapurna Textile Inc. the balance sheet reveals that its total current assets represents 33.7 percentage of the total asserts of which 9.52 percentage of total assets are in the form of investment in inventory.
The Vertical Analysis income statement Fig (2) reveals what portion of sales has been absorbed by various costs, and expenses incurred and the percentage of the total sales that remains as net income. For example, the table shows that 60 percent of total sales are incurred as cost of goods sold and only 13.54 percentage of total sales are in the form of net income to the firm.
2. Horizontal Analysis
The technique of Horizontal analysis involves preparation of comparative balance sheet and comparative income statement so as to highlight changes in the various assets, liabilities income and expenditure, and the resulting profit or loss. The changes may be expressed in absolute amounts or percentages (Smart, Megginson, & Gitman, 2007). The data may be presented for two years or for a number of successive years so as to examine the trend.
As a financial statement, balance sheet is concerned with summarizing assert owned by the firm and sources of borrowing and owned funds in acquiring these assets. Figure (3) shows a hypothetical balance sheet of Annapurna Textile Inc. as on June 2018.
Fig (3): Annapurna Textile Inc. Balance sheet on Dec 2006 (In million)
The left hand side of the balance sheet shows asserts of Annapurna Textile Inc. whereas the right hand side shows the liabilities and equity as on Dec 2006. In the above balance sheet, the assets are arrange in order of their convertibility into cash and liabilities and equity are arranged in order of their maturity. But, they can be ordered in reverse order. The proper interpretation of financial statement requires a clear and correct understanding of the basic divisions of balance sheet.
Finally, this technique involves preparation of Comparative Balance Sheet and Comparative Income Statement so as to highlight the changes in the various assets, liabilities, income and expenditure. In the Comparative Balance Sheet, the figures (3) of assets and liabilities are set out as at the beginning and at the June of the year along with the extent of increases or decreases between the two dates.
The Comparative Income Statement is drawn on the same principle as the Horizontal Balance Sheet. The statement is prepared in a vertical form. There are columns, as in a comparative balance sheet, to show the amount of income and expenditure for two years in (2005 and 2006) or more along with the increase or decrease in amounts as also percentage increases or decreases. The percentages reflects the changes that have occurred over successive periods. Unusual changes can thus be detected and their causes determined.
References
Milbourn, G., & Haight, T. (2005). Providing students with an overview of financial statements using the Dupont analysis approach. Journal of American Academy of Business, 6(1) , 46-50.
Ott, S., Riddiough, T., & Yi, H. (2009). Finance, investment and investment performance: Evidence from the REIT sector. Real Estate Economics, 33(1) , 203-207.
Smart, S., Megginson, W., & Gitman, L. (2007). Corporate Finance.