Analysis and Interpretation of Financial Statements Fundamentals of Accounting, Business and Management 2 @Comparison Standard One of the qualitative characteristics of a good financial statement is comparability Ability of the Financial Statement to create a basis and allow the identification of similarities and differences between the statements being compared.Comparison Standards that can be used by entities are the following: 1. Intracomparability The company’s financial statement for the current period are being compared with the financial statements of prior or earlier periods. Increases in the total net income, decreases in the total liabilities are possible indicators that could be used by the entity. This kind of comparison will point out the areas for improvements and may be used as performance evaluation tools for employees. 2. Intercomparability It deals with the comparative analysis of the company’s financial statement against a direct competitor. This is a very valuable tool especially for companies that do not have the monopoly of the market. More than anything else, the direct competitor's financial statements could show if our entity underperformed or overachieved in the recently concluded accounting period.3. Industry Standard In an open industry where there are many players involved, it would be more prudent for some to compare their company’s financial statements with the standard average for that certain industry. By looking at industry averages as a whole instead on a per competitor basis, the process would negate the seasonal fluctuations affecting the direct competitor. This would also apprise the company on where it stands financially in that certain industry.Financial Statements AnalysisHorizontal Analysis - Horizontal analysis uses financial statements of two or more periods. - All line items on the FS may be subjected to horizontal analysis. - Only the simple year-on-year grow this covered in lesson. Changes can be expressed in monetary value (peso) and percentages computed by using the following formulas: Peso Change = Balance of Current Year — Balance of Prior Year Peso Ch esochange 499 Dd sae = Balane of Prior Year(Cure asses Longer invesmenss Pant assets (ne) Inangtie asses Tost aces roo 3.2% 250) a5)% (25500) 64) (21000) (74)% (00 (36% (100,000) (600)% (123900) @00)% 2200 205% 200 53% (1.00) 74%KEY TAKEAWAYS «Horizontal analysis is used in the review of a company's financial statements over multiple periods. «It is usually depicted as a percentage growth over the same line item in the base year. «Horizontal analysis allows financial statement users to easily spot trends and growth patterns. «It can be manipulated to make the current period look better if specific historical periods of poor performance are chosen as a comparison.Vertical Analysis Also called common-size analysis, is a technique that expresses each financial statement item as a percentage of a base amount.‘Comparative income Statement For the year ended December 31, 2008 and 2007 ‘Comtot goods sold Gross profton sales ‘seang expenses General expenses ‘Tota operaang expenses ‘Operaang income Omer income Omer expences Income belore come ax Income ax ‘Amount ($) 1,498,000 1,043,000 455,000 106,000 160,000 3,500 162,500 71,500 100.0% 69.6% 30.4% 120% 69% 197% 107% 06% 113% 04% 10.9% 42% 61% ‘Amoure ($) 1,200,000 £820,000 147,000 97.400 244,400 136,600 11,000 100.0% 68.3% 317% 123% 31% 204% 11.3% 09% 122% 1.0% 11.2% 42% 64%‘Comparative Balance Sheet December 21, 2008 & 2007 Plant asset (net) Intangible assets ovat assets ‘Currentsabanes Longiterm kabites | ‘Total sabases Preferred 6% sock ‘Common stock Reaines earnings ‘oral sock holders’ equty ‘Toral kabines and sockholsers equty ‘Amount () 550,000 ‘95,000 444,500 0,000 41,139,500 210,000 100,000 310,000 150,000 ‘500,000 179,500 829,500 41,130,500 Percent 40.3% 23% 390% 44% 184% 22% 132% 43.9% 18.7% 100.0% ‘Amount ($) 533,000 177,500 «470,000 ‘50,000 1,230,500 150,000 173,500 787,500 1,230,500 Percent 43.3% 144% 38.2% 41% 100.0% 197% 16.3% 26.0% 122% 408% 12% 4.0%KEY TAKEAWAYS «Vertical analysis makes it easier to understand the correlation between single items on a balance sheet and the bottom line, expressed in a percentage. «Vertical analysis can become a more potent tool when used in conjunction with horizontal analysis, which considers finances of a certain period of time.Trend Analysis Trend analysis involves the collection of information from multiple time periods and plotting the information on a horizontal line for further review. The intent of this analysis is to spot actionable patterns in the presented information. In business, trend analysis is typically used in two ways, which are as follows: = Revenue and cost analysis. Revenue and cost information from a company's income statement can be arranged on a trend line for multiple reporting periods and examined for trends and inconsistencies. For example, a sudden spike in expense in one period followed by a sharp decline in the next period can indicate that an expense was booked twice in the first month. Thus, trend analysis is quite useful for examining preliminary financial statements for inaccuracies, to see if adjustments should be made before the statements are released for general use. @= Investment analysis. An investor can create a trend line of historical share prices, and use this information to predict future changes in the price of a stock. The trend line can be associated with other information for which a cause-and-effect relationship may exist, to see if the causal relationship can be used as a predictor of future stock prices. Trend analysis can also be used for the entire stock market, to detect signs of a impending change from a bull to a bear market, or the reverse. Accounting Too! @«Trend analysis is a technique used in technical analysis that attempts to predict the future stock price movements based on recently observed trend data. Trend analysis is based on the idea that what has happened in the past gives traders an idea of what will happen in the future. There are three main types of trends: short-, intermediate- and long-term. InvestopediaCompany B Income Statement (%) (%) (%) YEARL YEAR2 YEARS} Revenue 100.0°%| 100.0%) 100.0°%| Cost of Goods Sold 55.64% 52.12% 50.87% Gross Profit 44.36% 47.88% 49.13% Operating Expences Research Expences 7.02% 4.98% 5.67% Sales and Administrative 22.04% 22.56% 23.11% Total Operating Expenses 29.06% 22.54%| 28.78%! Operating Income 15.3% 20.34% 20.35% Interest Expense 0.55% 0.61% 0.48% Other Income (Expense) 1.44% 1.76% 1.69% Income before Taxes 16.19% 21.49% 21.56% Provision for Income Taxes 4.67% 4.88% 5.13% Net Income 11.52%) 16.61%! 16.43%!