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orizontal analysis of financial statementsinvolves comparison of a financial ratio, a benchmark, or a line item over

a number of accounting periods. This method of analysis is also known as trend analysis. Horizontal analysis allows

the assessment of relative changes in different items over time. It also indicates the behavior of revenues, expenses,

and other line items of financial statements over the course of time.

Accounting periods can be two or more than two periods. Accounting period can be a month, a quarter or a year. It

will depend on the analysts discretion when choosing an appropriate number of accounting periods. During the

investment appraisal, the number of accounting periods for analysis is based on the time horizon under

consideration.

Horizontal analysis of financial statements can be performed on any of the item in the income statement, balance

sheet andstatement of cash flows.For example, this analysis can be performed on revenues, cost of sales,

expenses, assets, cash, equity and liabilities. It can also be performed on ratios such as earnings per share (EPS),

price earning ratio, dividend payout, and other similar ratio.

Horizontal analysis can be performed in one of the following two different methods i.e. absolute comparison or

percentage comparison.

Absolute Comparison:

One way of performing horizontal analysis is comparing the absolute currency amounts of some items over the period

of time. For example, cash in hand at the end of an accounting period can be compared to other accounting periods.

This method is helpful in identifying the items which are changing the most.

Percentage Comparison:

In the second method of horizontal analysis, percentage differences in certain items are compared over a period of

time. The absolute currency amounts are converted into the percentages for the purpose of comparison. For

example, a change in cash from $5,000 to $5,500 will be reported as 10% increase in cash. It can also be reported as

110%, which means that the cash is 110% of the cash at the end of previous accounting period. This method is

useful when comparing performance of two companies of different scale and size

Vertical analysis of financial statementsis a technique in which the relationship between items in the

samefinancial statementis identified by expressing all amounts as a percentage a total amount. This method

compares different items to a single item in the same accounting period. The financial statements prepared by using

this technique are known as common size financial statements.

This analysis is performed on the income statement as well as the balance sheet.

Balance Sheet:

When applying this method on the balance sheet, all of the three major categories accounts (i.e. assets, liabilities,

and equity) are compared to the total assets. All of the balance sheet items are presented as a proportion of the total

assets. These percentages are shown along with the absolute currency amounts. For example, suppose a company

has three assets; cash worth $4 million, inventory worth $7 million and fixed assets worth $9million. The vertical

analysis method will show these as

Cash: 20%

Inventories: 35%

Fixed Assets: 45% Income Statement:

And when applying this technique to the income statement, each of the expense is compared to the total sales

revenue. The expenses are presented as a proportion of total sales revenue along with the absolute amounts. For

example, if the sales revenue of a company is $10 million and the cost of sales is $6 million, the cost of sales will be

reported as 60% of the sales revenue.

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The main advantage of using vertical analysis of financial statements is that income statements and balance sheets

of companies of different sizes can be compared. Comparison of absolute amounts of companies of different sizes

does not provide useful conclusions about their financial performance and financial position.

Usually the vertical analysis is performed for a single accounting period to see the relative proportions of different

account balances. But it is also useful to perform vertical analysis over a number of periods to identify changes in

accounts over time. It can help to identify unusual changes in the behavior of accounts. For example, if the cost ofsales has been consistently 45% in the history, then a sudden new percentage of 60% should catch the attention of

analysts. Reasons behind this change should be investigated and then measures should be taken to bring this

percentage back to its normal level.

Return on assets(ROA) is a financial ratio that shows the percentage of profit that a company earns in relation to its

overall resources (total assets). Return on assets is a key profitability ratio which measures the amount of profit made

by a company per dollar of its assets. It shows the company's ability to generate profits before leverage, rather than

by using leverage. Unlike other profitability ratios, such as return on equity (ROE), ROA measurements include all of

a company's assetsincluding those which arise from liabilities to creditors as well as those which arise from

contributions by investors. So, ROA gives an idea as to how efficiently management use company assets to generate

profit, but is usually of less interest to shareholders than some other financial ratios such as ROE.

Return on assets gives an indication of the capital intensity of the company, which will depend on the industry.

Capital-intensive industries (such as railroads and thermal power plant) will yield a low return on assets, since they

must possess such valuable assets to do business. Shoestring operations (such as software companies and personal

services firms) will have a high ROA: their required assets are minimal. The number will vary widely across different

industries. This is why, when using ROA as a comparative measure, it is best to compare it against a company's

previous ROA figures or the ROA of a similar company.

Calculation (formula)

Return on assets is calculated by dividing a company's net income(usually annual income)by its total assets, and

is displayed as a percentage. There are two acceptable ways to calculate return on assets: using total assets on

the exact dateor averagetotal assets:

ROA = Net Income after tax / Total assets (or Average Total assets)

Instead of net income,comprehensive incomecan be used as the formula's numerator (seestatement of

comprehensive income).

Return On Capital Employed (ROCE)Profitability ratiosPrintEmail

Definition

Return on capital employed (ROCE)is a measure of the returns that a business is achieving from the capital

employed, usually expressed in percentage terms. Capital employed equals a company's Equity plus Non-current

liabilities (or Total Assets Current Liabilities), in other words all the long-term funds used by the company. ROCE

indicates the efficiency and profitability of a company's capital investments.

ROCE should always be higher than the rate at which the company borrows otherwise any increase in borrowing willreduce shareholders' earnings, and vice versa; a good ROCE is one that is greater than the rate at which the

company borrows.

Calculation (formula)

ROCE = EBIT / Capital Employed = EBIT / (Equity + Non-current Liabilities) = EBIT / (Total Assets - Current

Liabilities)

A more accurate variation of this ratio isreturn on average capital employed(ROACE), which takes the average of

opening and closing capital employed for the time period.

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One limitation of ROCE is the fact that it does not account for the depreciation and amortization of the capital

employed. Because capital employed is in the denominator, a company with depreciated assets may find its ROCE

increases without an actual increase in profit.

Financial leverage ratios(debt ratios) measure the ability of a company to meet its financial obligations when they

fall due. Financial leverage ratios (debt ratios) indicate the ability of a company to repay principal amount of its debts,

pay interest on its borrowings, and to meet its other financial obligations. They also give insights into the mix of equityand debt a company is using.

Financial leverage ratios usually compare the debts of a company to its assets. The common examples of financial

leverage ratios include debt ratio, interest coverage ratio, capitalization ratio, debt-to-equity ratio, andfixed assets to

net worthratio.

Financial leverage ratios indicate the short-term and long-term solvency of a company. They give indications about

the financial health of a company. These ratios give indications whether the company has got enough financial

resources to cover its financial obligations when the creditors and lenders seek their payments.

A company with adverse financial leverages ratios may not be able to cover its debts and therefore may go bankrupt.

These ratios can give warnings to the shareholders and directors of potential financial difficulties. The shareholders

and directors can take actions to prevent the company from going bankrupt.

Financial leverage ratios help to determine the overall level of financial risk faced by a company and its shareholders.

Generally speaking, the greater the amount of debt of a company the greater the financial risk is. A company with

greater amount of debts and financial obligations is more likely to fail to repay its debts.

Financial leverage ratios are of little use in isolation. To draw meaningful conclusions about the financial health of a

company, trend analysis and industry analysis needs to be done. Trend and industry analysis will tell how well the

financial position is being managed. Trend analysis will indicate whether the financial position of a company is

improving or deteriorating over time. Industry analysis will indicate how well the company is performing as compared

to other companies in the same industry.

Companies need to carefully manage their financial leverage ratios to keep their financial risk at acceptable level.

Careful management of financial leverage ratios is also important when seeking loans from banks and financial

institutions. Favorable ratios can help the company to negotiate a favorable interest rate.

Fixed Assets to Net WorthDebt ratiosPrintEmail

Fixed assets to net worthis a ratio measuring the solvency of a company. This ratio indicates the extent to which

the owners' cash is frozen in the form of fixed assets, such as property, plant, and equipment, and the extent to which

funds are available for the company's operations (i.e. for working capital).

Calculation (formula)

Fixed assets to Net Worth = Net fixed assets / Net worth

Norms and Limits

Fixed assets to net worth ratio 0.75 or higher is usually undesirable, as it indicates that the firm is vulnerable to

unexpected events and changes in the business climate. But the term "fixed assets" (non-GAAP term) has differentinterpretations so it's difficult to use and compare this ratio. That is why weprefer to use similar ratio "Non-current

assets to net worth"implicating IFRS term "Non-current assets".

Revenue per EmployeeProfitability ratiosPrintEmail

Definition

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Revenue per employeemeasures the amount of sales generated by one employee. This is a measure of

performance of human resources of a company. It is an indicator of productivity of c ompanys personnel. It also

indicates how efficiently a company is utilizing its human resources.

Generally speaking higher the revenue per employee figure is, the better it is. But revenue per employee will vary in

different industries according to intensity of labor. Revenue per employee is less in the industries which are labor-

intensive. On the other hand this metric is higher in the high tech, low labor-intensive companies.Revenue per employee is an absolute figure in terms of a currency; therefore, it may appear to be less useful in

analytical sense. For analytical purposes this figure should be compared with the historical data to see any

improvement or deterioration. It should also be compared with the other similar companies operating in the same

industry. This comparison over time and across industry will give usefully insights into the productivity of personnel.

Revenue per employee is also influenced by the age of a company. Young companies usually have small revenues

and they are usually in the process of hiring employees to fill key positions. Therefore their revenue per employee is

lower than the established companies.

Calculation (formula)

The formula for calculation of revenue per employee is given below

Revenue per Employee = Sales Revenue / Number of Employees

Usually the number of employees keeps on changing over the period. Therefore, it is preferable to use average

number of employees during the period. The figure for sales revenue can be found in theincome statement.

Sometimes earning per employee is also calculated by using net income, instead of sales revenue, in the above

formula. This is also a useful measure of productivity of employees

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