Page 207 - DMGT104_FINANCIAL_ACCOUNTING

Unit 9: Analysis and Interpretation of Financial Statements

analysis is called horizontal analysis. For this type of analysis the data of the different Notes
years are kept in the different columns horizontally. The percentage increases of one
year’s figures are taken as base year’s figures. The base year may be the beginning year,
preceding year or different year (chain base). Thus horizontal analysis may be done for
periodical long-term, trend analysis and comparative study.
2. Vertical Analysis: It is also known as structural analysis or static analysis. Under this type
of analysis a single set of financial statement prepared on a particular date is analysed. In
this analysis only the quantitative relationship is created or one item of the financial
statement is compared with other items of that statement as percentage of assets to total
assets and percentage of profit to sales, etc. The example of this analysis is the common
size statement and financial ratio.

In the modern financial analysis both the above analysis are like backbone.

9.4 Techniques of Analysis and Interpretation

To simplify the financial statements for the purpose of analysis and interpretation the following
techniques/tools are used:
Comparative Financial Statement Analysis

These statements are very important for the analysis and interpretation. Inter-firm financial
statements can be prepared for the comparison of the results and financial position of two firms.
Similarly, the inter-period financial statements can be prepared. Inter-period comparison is
done very easily by inter-period financial statements. For the preparation of inter-period
comparison the accounting data of the different periods are shown in the different columns
along with the absolute and relative changes. Relative changes are calculated in the percentage
based on the previous year. Among the comparative financial statements the following statements
are included:
1. Comparative Balance Sheet: As per Prof. Fulke, “Comparative Balance Sheet is the study
of the trend of the same business enterprise on the different dates”. In the comparative
balance sheet the changes in the amount of various items of the balance sheets of the same
business as liabilities, assets and owner’s equity in the two periods are presented in such
a way so that the users of the financial statements may observe the changes easily. In the
single balance sheet only the closing balances of different accounts are shown while in the
comparative balance sheet the closing balances of the different items are showed along
with their absolute changes and relative changes. Comparative balance sheet is very
useful to study the trends in the changes of items. The comparative balance sheet is more
concerned with the changes in assets, liabilities and owner’s equity and their trends while
in the single balance sheet is concerned with the book values of the items and the financial
position of the business. However, the comparative balance sheet does not show the
relationship of one item with the other items.
To prepare the comparative balance sheet, the four columns are drawn. In the first two
columns of amount the absolute data of the two balance sheets are showed and in the third
column increase or decrease in the assets and liabilities as well as owner’s equity are
showed and in the fourth and last column the percentage of increase or decrease is showed.
After preparing the comparative balance sheet the analyst gives his interpretation regarding
the financial position (short-term and long-term) and profitability of the business.
Comparative balance sheet may be understood easily in the following illustration.

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