ACCT CH 15

ACCT 2301 CH 15

3 Tools of Financial Statement Analysis

1. Horizontal Analysis - provides a year to year comparison of a company’s performance in different periods.

2. Vertical Analysis - provides a way to compare different companies.

3. Ratio Analysis - can be used to provide information about a company’s performance. It is used most effectively to measure a company against other companies in the same industry and to denote trends within the company.

Annual report

Provides infgormation about a company’s financial condition.

MD&A

(Management’s Discussion and Analysis of Financial Condition and Results of Operations)

This section of the annual report is written by the company and therefore could be biased. However, it reports the company’s explanation of its financial statements and discusses its performance. Along with information not found on financial data like how the company plans to spend its cash during the next year and expected PLANT purchases.

Environmental, Social, and Governance (ESG) Reports

• Environmental-Is the company a good steward of the planet?

• Social-Does the company support its employees and its community?

• Governance-Who controls the company, and how are the leaders held accountable?

This kind of reporting is not currently mandatory.

Horizontal Analysis

The study of the percentage changes in line items from comparative financial statements. Compares the change in each financial statement item from one year to the next.

Steps To Compute a Percentage Change in Comparative Statements

1. Compute the dollar amount of the change in a line item from the earlier period* to the later period.

2. Divide the dollar amount of change by the earlier period amount and multiply by 100.

*Called the base period.

Trend Analysis and Formula

A form of horizontal analysis. Trend percentages indicate the direction a business is taking. Determines if trend is positive or negative over longer period of time. Computed by selecting a base period (the earliest year) and set them to equal 100%. The subsequent years are expressed as a percentage of the base amount.

Trend % = (any period amount / Base period amount) x 100

Vertical Analysis and Formula

Shows the relationship of each item to its base amount, which is the 100% figure. Every other item on the statement is then reported as a percentage of that base. For Income Statement, Net Sales Revenue is the base. For Balance Sheet, total assets is the base.

=(Specific item / Base amount) x 100

Common-Size Statement

Reports only percentages(the same percentages from Vertical Analysis). By only reporting percentages it removes the dollar value bias when comparing one company to another company.

Dollar Value Bias

The bias one sees from comparing numbers in absolute (dollars) rather than relative (percentage) terms. For some companies 1 million is a large number but when compared with larger billion dollar businesses it makes it harder to compare.

Benchmarking

The practice of comparing a company’s performance with best practices from other companies. Often uses the common-size percentages in a graphical manner to highlight differences.

2 Main Types of Benchmarking

1. Benchmarking against a key competitor

2. Benchmarking against the industry average