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Lecture No. 8 Financial Statement Analysis Analysis of Income Statement and Balance Sheet

This document discusses techniques for analyzing financial statements, including vertical analysis, horizontal analysis, and ratio analysis. Vertical analysis involves expressing each financial statement item as a percentage of a total item such as total assets or net sales. Horizontal analysis compares financial information across years. Ratio analysis examines the relationships between financial statement elements to assess a company's profitability, liquidity, and solvency. Financial statement analysis provides useful information for investors, creditors, and analysts to evaluate a company's performance and financial position.

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191 views2 pages

Lecture No. 8 Financial Statement Analysis Analysis of Income Statement and Balance Sheet

This document discusses techniques for analyzing financial statements, including vertical analysis, horizontal analysis, and ratio analysis. Vertical analysis involves expressing each financial statement item as a percentage of a total item such as total assets or net sales. Horizontal analysis compares financial information across years. Ratio analysis examines the relationships between financial statement elements to assess a company's profitability, liquidity, and solvency. Financial statement analysis provides useful information for investors, creditors, and analysts to evaluate a company's performance and financial position.

Uploaded by

sajjad
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Financial Statement Analysis, BBA 7th Semester

Lecture No. 8
FINANCIAL STATEMENT ANALYSIS

Analysis of income statement and balance sheet:

Financial Statements are like the Instrument panels of a business. There are
different needs of different users of these statements. Users can be outside users
and internal users. Identity of user is important, so as to provide him/her with
relevant information.
Financial statement analysis is the process of examining relationships among
financial statement elements and making comparisons with relevant information.
It is a valuable tool used by investors and creditors, financial analysts, and others
in their decision-making processes related to stocks, bonds, and other financial
instruments. The goal in analyzing financial statements is to assess past
performance and current financial position and to make predictions about the
future performance of a company. Investors who buy stock are primarily
interested in a company's profitability and their prospects for earning a return on
their investment by receiving dividends and/or increasing the market value of
their stock holdings. Creditors and investors who buy debt securities, such as
bonds, are more interested in liquidity and solvency: the company's short-and
long-run ability to pay its debts. Financial analysts, who frequently specialize in
following certain industries, routinely assess the profitability, liquidity, and
solvency of companies in order to make recommendations about the purchase or
sale of securities, such as stocks and bonds.
Analysts can obtain useful information by comparing a company's most recent
financial statements with its results in previous years and with the results of
other companies in the same industry. Three primary types of financial statement
analysis are commonly known as horizontal analysis, vertical analysis, and ratio
analysis.

ANALYSIS TECHNIQUES

Vertical Analysis
When using vertical analysis, the analyst calculates each item on a single
financial statement as a percentage of a total. The term vertical analysis applies
because each year's figures are listed vertically on a financial statement. The total
used by the analyst on the income statement is net sales revenue, while on the
balance sheet it is total assets. This approach to financial statement analysis, also
known as component percentages, produces common-size financial statements.
Common-size balance sheets and income statements can be more easily
compared, whether across the years for a single company or across different
companies
Financial statement item that is used as a base value. All other accounts on the
financial statement are compared to it. In the balance sheet, for example, total

Page 1 of 2 Institute of Management Sciences |KUST, Kohat.


Financial Statement Analysis, BBA 7th Semester

assets equals 100%. Each asset is stated as a percentage of total assets. Similarly,
total liabilities and stockholders' equity are assigned 100% with a given liability
or equity account stated as a percentage of the total liabilities and stockholders'
equity. For the income statement, 100% is assigned to net sales with all revenue
and expense accounts related to it. Under vertical analysis, the statements
showing the percentages are referred to as Common Size Financial Statements.
Common size percentages can be compared from one period to another to
identify areas needing attention.
Horizontal Analysis
When an analyst compares financial information for two or more years for a
single company, the process is referred to as horizontal analysis, since the analyst
is reading across the page to compare any single line item, such as sales
revenues. In addition to comparing dollar amounts, the analyst computes
percentage changes from year to year for all financial statement balances, such as
cash and inventory. Alternatively, in comparing financial statements for a
number of years, the analyst may prefer to use a variation of horizontal analysis
called trend analysis. Trend analysis involves calculating each year's financial
statement balances as percentages of the first year, also known as the base year.
When expressed as percentages, the base year figures are always 100 percent,
and percentage changes from the base year can be determined.
Time series analysis of financial statements covering more than one accounting
period; also called Trend Analysis. It looks at the percentage change in an
account over time. The percentage change equals the change over the prior year.
For example, if sales in 20X0 are $100,000 and in 20X1 are $300,000, there is a
200% increase ($200,000/$100,000). By examining the magnitude of direction of a
financial statement item over time, the analyst can evaluate its reasonableness.
Common Size Financial Statement
A company financial statement that displays all items as percentages of a
common base figure. This type of financial statement allows for easy analysis
between companies or between time periods of a company.

RATIOS ANALYSIS
4. ANALYSIS BY RATIOS:

Financial Ratios are like financial temperatures, which give the state of the health
of a business. This analysis technique is most widely used. In these interlinkages
of Income Statement and Balance Sheet items are established and inferences are
drawn there from.

Page 2 of 2 Institute of Management Sciences |KUST, Kohat.

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