Loading acctg211..

Analyzing Financial Statements

When you analyze financial statements, you determine financial performance in a number of ways. Normally, you would determine performance as follows:

• Compare the results of the company's operations from year to year. Essentially, you compare this year’s financial information with previous years, looking for significant changes or trends.
• Compare the results with the results of key competitors.
• Compare the results with the results of the industry as a whole.

There are three main ways to analyze financial statements:

• A horizontal analysis provides a year-to-year comparison of the company’s performance, looking at company information from one year to the next. You would calculate percentage changes for line items in the income statement and balance sheet from year to year. The performance trend is studied to see if the financial condition of the company is improving or deteriorating. When you hear a company saying that sales have increased 5% in the past year, it is using horizontal analysis to explain these results.
• In a vertical analysis, you would show each major item in the financial statements as a percentage of a base amount—for example, when you prepare a vertical analysis on a balance sheet, you would show each major item as a percentage of total assets. When you prepare a vertical analysis on an income statement, you would show each major item as a percentage of sales or net sales. A vertical analysis allows the company to see changes in the relationships among accounts from year to year, providing it with a way to compare its data to competitors. This is very useful when comparing differently sized companies. The performance trend is studied to see if the company's financial condition is improving or deteriorating.
• According to Investopedia (Investopedia, LLC, 2016), ratio analysis is

  used to evaluate various aspects of a company’s operating and financial performance, such as its efficiency, liquidity, profitability, and solvency. The trend of these ratios over time is studied to check whether they are improving or deteriorating. Ratios are also compared across different companies in the same industry to see how they stack up, and to get an idea of comparative valuations.