“Copyright and Terms of Service Copyright © Texas Education Agency. The materials found on this...

Horizontal and Vertical Analysis

Financial Analysis

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Copyright © Texas Education Agency, 2014. All rights reserved.

Two Types of Financial Analysis

Horizontal

Vertical

3Copyright © Texas Education Agency, 2014. All rights reserved.

What is Horizontal Analysis?

Also called Trend Analysis

Shows changes in amounts on financial statements over time

Compares the same accounts over time (apples to apples)

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Uses a Comparative Balance Sheet (includes more than one accounting period on the same document)


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Calculations and Horizontal Analysis

Changes can be shown in dollar amounts or percentages.

Dollar amounts are simply calculated by subtracting the original period from the current period. (example on next slide)

Percentages are calculated by dividing the dollar amount of change by the amount in the original period, then multiplying the answer by 100. (example on next slide)


Horizontal Analysis-Balance Sheet Example

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ABC CorporationComparative Balance Sheet

December 31, 2010 and 2011

Increase (Decrease)

Assets

2011

2010 Amount Percent

Current Assets: Cash $ 7,000 $6,500 $500 7.7 Accounts Receivable Supplies Prepaid Insurance

39,0003,5004,000

25,0005,0003,700

14,000(1,500)

300

56.0(30.0)

8.1 Total Current Assets $53,500 $40,200 13,300 33.1 Property, Plant, and Equipment: Land 40,000 54,475 (14,475) (26.6) Buildings 95,000 112,000 (17,000) (15.2) Equipment 30,000 17,000 13,000 76.5 Total Property, Plant, and Equipment

165,000 183,475 (18,475) (10.1)

Total Assets $218,500

$223,675 $(5,175) (2.3)

Liabilities and Stockholder’s Equity Current Liabilities Accounts Payable Salaries Payable Total Current Liabilities Long-Term Liabilities Mortgage Payable Bonds Payable Total Long-Term Liabilities

$9,00017,00026,000

70,00032,000

102,000

11,30016,50027,800

79,10034,175

113,275

(2,300)500

(1,800)

(9,100)(2,175)

(11,275)

(20.4)3.0

(6.5)

(11.5)(6.4)

(10.0) Total Liabilities 128,000 141,075 (13,075) (9.3)Stockholder’s Equity Capital Stock Retained Earnings Total Stockholder’s Equity

65,00025,50090,500

54,00028,60082,600

11,000(3,100)

7,900

20.4

(10.8)9.6

Total Liabilities and Stockholder’s Equity

$218,500

$223,675 (5,175) (2.3)

To calculate dollar amount of change: 2011 amounts – 2010 amounts = dollar amount of increase or (decrease)

To calculate percent change: dollar amount of change/dollar amount of 2010 (previous amount)


Horizontal Analysis-Income Statement Example

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ABC CorporationComparative Income Statement

For the Year Ended December 31, 20--

Increase (Decrease)

Revenue 2011 2010 Amount Percent Gross Sales Less: Sales Discounts Net Sales

$531,00018,500

512,500

499,05021,500

477,550

31,950(3,000)34,950

6.4(14.0)

7.3 Cost of Goods Sold

Merchandise Inventory, Jan. 1

157,000 136,265 20,735 15.2

Net Purchases 45,000 57,000 (12,000)

(21.1)

Goods Available for Sale 202,000 193,265 8,735 4.5 Less: Merch. Inventory, Dec. 31

53,000 27,045 25,955 96.0

Cost of Goods Sold 149,000 166,220 (17,220)

(10.4)

Gross Margin 363,500 311,330 52,170 16.8 Operating Expenses Salaries 147,000 143,500 3,500 2.4 Rent 5,200 4,800 400 8.3 Advertising 9,800 8,700 1,100 12.6 Total Operating Expenses

162,000 157,000 5,000 3.2

Income before Taxes 201,500 154,330 47,170 30.6Income Tax 26,500 20,065 6,435 32.1Net Income 175,000 134,265 40,735 30.3

To calculate dollar amount of change: 2011 amounts – 2010 amounts = dollar amount of increase or (decrease)

To calculate percent change: dollar amount of change/dollar amount of 2010 (previous amount)


EXPECTATIONS

For example, if management expected Net Income to increase by 20% and it only increased 10%, management will need to look at whether Sales could have decreased or Expenses could have increased.

For example, if Accounts Receivable decreased by 30% from one year to the next, this could mean that either the existing credit accounts are being paid off by the customers, or new customers could be paying in cash as opposed to credit.

Horizontal Analysis Implications - Examples


• Assume a company’s change in Accounts Receivable over five years is as follows:

Graphing Trends

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To make the graph, create a spreadsheet with the years examined and the dollar amount of the changes.

Graphing can visually show trends of increases and decreases in accounts over time.


What is Vertical Analysis?

Also called common-size analysis

Amounts are shown as a percentage

Amounts not necessarily compared over time to the same accounts, as in horizontal or trend analysis, but different amounts are compared to a common total on the same financial statement


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Calculations and Vertical Analysis

Calculated by dividing the individual amount by a base amount, then multiplying by 100. (examples on the next slide)

On the Balance Sheet, Total Assets, Total Liabilities, or Total Stockholders’ Equity are typically used as the base amounts.

On the Income Statement, Total Sales is typically the base amount.


Vertical Analysis-Balance Sheet Example

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ABC CorporationBalance Sheet

December 31, 20—

Assets Current Assets: Cash $ 7,000 3.2% Accounts Receivable Supplies Prepaid Insurance

39,0003,5004,000

17.91.61.8

Total Current Assets $53,500 24.5 Property, Plant, and Equipment: Land 40,000 18.3 Buildings 95,000 43.5 Equipment 30,000 13.7 Total Property, Plant, and Equipment

165,000 75.5

Total Assets $218,500 100.0% Liabilities and Stockholder’s Equity Current Liabilities Accounts Payable Salaries Payable Total Current Liabilities Long-Term Liabilities Mortgage Payable Bonds Payable Total Long-Term Liabilities

$9,00017,00026,000

70,00032,000

102,000

4.1%7.8

11.9

32.014.646.7

Total Liabilities 128,000 58.6Stockholder’s Equity Capital Stock Retained Earnings Total Stockholder’s Equity

65,00025,50090,500

29.711.741.4

Total Liabilities and Stockholder’s Equity

$218,500 100.0%

Each of the items on the Balance Sheet is divided by

a total.

The Asset section is divided by Total Assets.

The Liabilities & Stockholder’s

Equity section is divided by Total

Liabilities & Stockholder’s Equity.


Vertical Analysis-Income Statement Example

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ABC CorporationIncome Statement

For the Year Ended December 31, 20--

Revenue % Sales Less: Sales Discounts Net Sales

$531,00018,500

512,500

103.63.6

100.0%

Cost of Goods Sold

Merchandise Inventory, Jan. 1 157,000 30.6 Net Purchases 45,000 8.8 Goods Available for Sale 202,000 39.4 Less: Merchandise Inventory, Dec. 31

53,000 10.3

Cost of Goods Sold 149,000 29.1Gross Margin 363,500 70.9 Operating Expenses Salaries 147,000 28.7 Rent 5,200 1.0 Advertising 9,800 1.9 Total Operating Expenses 162,000 31.6Income before Taxes 201,500 39.3Income Tax 26,500 5.2Net Income $175,000 34.1%

All accounts on the Income Statement are

divided by a total, in this case, Net Sales.

** If there are no Sales Discounts or Sales

Returns and Allowances, each item can be divided

by Total Sales. **


EXPECTATIONS

For example, if Accounts Receivable represents a large percent of Total Assets (that percentage would have to be established by management), management may want to tighten its credit policies.

For example, if the Cost of Goods Sold is an especially high percent of Sales or Revenue, more sales will be necessary to cover the costs.

Vertical Analysis Implications - Examples


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Independent Practice Assignments

Trend Analysis Assignment #1- In pairs, students will select a company to prepare a trend analysis. Locate a Comparative Balance Sheet and Income Statement for the company. Then the students will prepare a trend analysis for at least three accounts each from the company’s balance sheet and three accounts from the income statement. They should also include their own conclusion for each trend and a recommendation to management based on the increases or decreases they discover. They may prepare this on a spreadsheet program (or manually) and will present their findings to the class.

Common-size Analysis Assignment #2- Individually, students will select a company and locate a Balance Sheet and Income Statement and prepare a vertical analysis of at least three items on each statement. These items are to be compared to a base amount which will equal 100% so that students will then create a pie chart for each of the two financial statements. Students will then make a conclusion and recommendation based on the results of the two pie graphs.

Trend Analysis Graph Assignment # 3- Students will locate the Comparative Balance Sheet or Comparative Income Statement for a company of their choosing. They will select at least five accounts for the statement they choose and create graphs for each account showing the change over the different time periods. They can follow a format similar to the one in the presentation or a format of their choosing— as long as a spreadsheet displays the changes in the five accounts across the time periods and five graphs total (one for each spreadsheet). They should make a statement about each of the analyses in order to make a possible recommendation to management.


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