Module 3 Flashcards
Horizontal Analysis
The primary objective of horizontal analysis is to highlight the change in company performance over time. Therefore, unlike vertical analysis, horizontal analysis requires at lease two years worth of financial statements so that one year may be compared to the other.
Like vertical analysis, horizontal analysis also expresses the financial statements as percentages, rather than dollar values. Horizontal analysis always starts with the earliest year available, which is also called the “ base year .”
Vertical Analysis
The primary objective of vertical analysis is to measure the contribution of each line item to a balance sheet or an income statement.
Vertical analysis expresses each financial statement line item as a percent of the largest amount on that statement. On the income statement, this is net sales (or revenue). On the balance sheet, this is total assets.
Financial Ratio Analysis
are effective tools for measuring the financial performance of a company because they provide a common basis for evaluation – for instance, the amount of gross profit generated by each dollar of sales for different companies.
Numbers that appear on financial statements need to be evaluated in context. It is their relationship to other numbers and the relative changes of these numbers that provide some insight into the financial health of a business. Ratio analysis alone will not provide a definitive financial evaluation. One of the main purposes of ratio analysis is to pinpoint areas that require further analysis and investigation. It is used as one analytic tool, which, when combined with informed judgment, offers insight into the financial performance of a corporation.
Classified Income Statement
3 Sections (typically):
Gross margin section. Subtracts the cost of goods sold from revenue, to arrive at the gross margin. This information is useful for ascertaining the amount of profit generated strictly from the sale of goods and services. The line items usually included in this section are:
- Gross revenue
- Less: Sales discounts and allowances
- Cost of direct materials
- Cost of direct labor
- Cost of factory overhead
Operating expenses section. Summarizes the cost of all operating expense line items into a subtotal, followed by a profit or loss from operations line item. This information is useful for determining the ability of a business to generate a profit from its core operating activities. The line items usually included in this section are:
- Accounting and legal expense
- Commissions expense
- Compensation and benefits expense
- Insurance expense
- Rent expense
- Supplies expense
- Utilities expense
Non-operating expenses section. Summarizes all expenses not related to operations. This information adjusts operating income by any additional factors to arrive at net profit or loss for the entire entity. The line items usually included in this section are:
- Gain/loss on sale of assets
- Interest income/expense
- Taxes
Gross Margin Calculation
Net Sales - Cost of Goods Sold
Net Sales Calculation
Gross Sales - Returns and Refunds
The financial statements of publicly traded companies are public records. You can obtain a copy either by:
- Visiting the Company’s own website (usually under the “Investor Relations” tab)
- Visiting the SEC Edgar database and searching for the 10-K form: https://www.sec.gov/edgar/searchedgar/companysearch.html
- Visiting Morning Star and entering the company’s name or stock symbol: http://www.morningstar.com/stocks.html
- Visiting Yahoo Finance and entering the company’s name or stock symbol: https://finance.yahoo.com/
Form 10-K
Annual report which provides a comprehensive overview of the corporation’s business and financial condition and includes audited financial statements. Although similarly named, the annual report on Form 10-K is distinct from “the annual report to shareholders”, which corporations must send to its stockholders when it holds an annual meeting to elect directors. For larger filers, the 10-K must be filed within 60 days of their fiscal year end.
Form 10-Q
The Form 10-Q includes unaudited financial statements and provides a continuing view of the corporation’s financial position during the year. The report must be filed for each of the first 3 fiscal quarters of the corporation’s fiscal year. For larger filers, this must be done within 40 days of the end of the quarter.
Form 8-K
In addition to filing Form 10-K and 10-Q, public corporations must report material corporate events on a more current basis. Form 8-K is the “current report” companies must file with the SEC to announce major events that are important to investors and creditors.
Trend Analysis
Analyzing the same corporation over time
Comparative Analysis
Analyzing similar corporations at the present time
Comparative Trend Analysis
Analyzing similar corporations over time
horizontal analysis
- each financial statement line item is expressed as a percent of the base year (typically the first year shown).
- good for highlighting the growth (or shrinkage) in financial statement line items from year to year and is particularly useful for trend analysis.
Vertical analysis
- Expresses each financial statement line item as a percent of the largest amount on the statement.
- On the income statement, this is net sales and on the balance sheet it is total assets.
