Financial Analysis

Used by decision makers to interpret accounting or financial information We will focus on a few common methods of financial analysis: – Trend Analysis – Comparative Financial Statement (Horizontal) – Common-Size Statement (Vertical) Analysis – Ratio Analysis

Trend Analysis Comparing the financial statements of two or more years allows businesses to focus on significant changes. The financial data can be presented in dollars, percentages or charted. Trends are one of the most important indicators of a companies financial performance Ideally, revenue and profits increase over time

Let’s take a McDonalds $23,522,400$22,744,700$24,074, %105.8% $4,313,200$4,551,000$4,946, %108.6% Revenue Net Income

Comparative Financial Statements (Horizontal Analysis) One method of analysing financial data from several years is known as comparative or horizontal analysis. The most current year is placed on the left column. The difference between years can be calculated both in dollars and percentage. Increases or decreases over previous years can be calculated by subtracting the current year from the base year (oldest year). Negative results aren’t always bad…why?

How To Complete a Horizontal Analysis Take the difference between the current year and the previous year Divide this answer by the value in the CURRENT year Convert decimal answer into a decimal

Horizontal Analysis Balance Sheet:

Sample from Income Statement:

Common-Size Analysis (Vertical) Another common method of comparing financial statements for several years is by considering items as a percentage of a common item. In the income statement, this common item is often sales. In the example below, total sales is the basis of comparison for all other items on the income statement. This is a condensed version of the income statement and indicates the key income statement figures only. This method is widely used to compare different companies of different sizes (Ex. Jim’s Video vs Blockbuster)

How to Complete a Vertical Analysis The first number respresents 100%, everything else is a percentage of that value (comparing all number to that value) Divide the numbers, individually, by the number in step 1. Convert decimal number into percentage

Example from an Income Statement:

Common-Size Comparative Income Statement For the years ended December 31, 20-6, 20-5 Company A%Company B% Sales100,000 75,000 Cost of Goods Sold39,000 41,200 Gross Profit61,000 33,800 Operating Expenses 36,000 10,800 Net Income25,000 23,000 Which is the more profitable company in terms of dollars? Which is the more profitable company in terms of percentages? Which company would you prefer to own?