Page 174 - DMGT202_COST_AND_MANAGEMENT_ACCOUNTING

Unit 10: Analysis of Financial Statements

industry. Three primary types of financial statement analysis are commonly known as horizontal Notes
analysis, vertical analysis, and ratio analysis.

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.
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.
Ratio Analysis

Ratio analysis enables the analyst to compare items on a single financial statement or to examine
the relationships between items on two financial statements. After calculating ratios for each

year’s financial data, the analyst can then examine trends for the company across years. Since
ratios adjust for size, using this analytical tool facilitates inter-company as well as intra-company
comparisons.

Notes The entire fi nancial statement analysis can be classifi ed into various categories:

Comparative fi nancial statements
Common size fi nancial statements
Trend percentages
Fund fl ow statements

Cash flow statements and
Ratio analysis
Self Assessment

Fill in the blanks:
1. When an analyst compares financial information for two or more years for a single

company, the process is referred to as ........................ analysis.

2. ........................ enables the analyst to compare items on a single financial statement or to
examine the relationships between items on two fi nancial statements.
3. When using ........................, the analyst calculates each item on a single fi nancial statement
as a percentage of a total.
10.2 Tools for Analysis and Interpretation of Financial Statement

In assessing the significance of various financial data, experts engage in ratio analyses, the process

of determining and evaluating financial ratios. A financial ratio is a relationship that indicates

something about a company’s activities, such as the ratio between the company’s current assets,
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