WEEK 4 Analysis of Financial Statements: Traditional Approach

Financial Statements Analysis

the process of selecting related data from financial statements to evaluate the entity’s past financial position and operating performance and predict outcome of future operations.

Three traditional approaches

1. Horizontal or Comparative Approach

2. Vertical or Common-size Approach

3. Trend Approach

Horizontal or Comparative Approach

analytical tool that evaluates the present performance of an entity compared to last year’s. The analysis reflects the differences in absolute amount and in percentage between two periods only, namely the present year and the previous year

Liquidity Analysis

the ability of the business to pay its currently maturing liabilities using their current assets as they fall on its due date.

Solvency Analysis

the ability to pay long-term liabilities.

Profitability Analysis

addresses a very basic goal of any business – to earn the highest possible profit or return on its investment.

Vertical or Common-size Approach

an analytical tool that determines the proportion of an item in the financial statements in relation to the total. The accounting period involved in the mathematical process is one or single period only.

Trend Percentage Approach

used to analyze the financial statements that extend beyond two years by using index numbers or percentages. Trend analysis makes a comparative study of an operating performance of the business over a few years. Data for three years are the minimum requirements for this type of analysis