TOPIC 4: OVERVIEW OF

ANALYSIS TECHNIQUES
Financial Statements Are
Designed for Analysis
Classified Comparative Consolidated
Financial Financial Financial
Statem ents Statements Statements

Itemswithcertain Amounts from Inform ationfor the

characteristicsare several years parent andsubsidiary
groupedtogether. appear side by side. arepresented.

Results Helps identify Presentedasif

instandardized, significant thetwocom panies
m eaningful changes and areasingle
subtotals. trends. businessunit.
 Analysis Tools/Analysis techniques

• Comparative financial statement analysis (horizontal analysis)

• Common-size financial statement analysis (vertical analysis)
• Ratio analysis
• Cash flow analysis
• Valuation

3
 Tools of Analysis

Horizontal Dollar &

analysis
Trend
Percentage
Percentages
Changes

Vertical Component
analysiS Percentages
Ratios
13--5
Helps highlight unusual fluctuations

6
Dollar and Percentage Changes
Dollar Change:

Dollar Analysis Period Base Period

Change = Amount – Amount

Percentage Change:
Percent Base Period
Change = Dollar Change
÷ Amount
Dollar and Percentage Changes
Evaluating Percentage Changes in
Sales and Earnings

Sales and earnings In measuring quarterly

should increase at changes, compare to
more than the rate the same quarter in
of inflation. the previous year.

Percentages may be
misleading when the
base amount is small.
Year to year change analysis
• Comparing financial statements over relatively short time periods—two to three year
• Steps:
• 1. choose a base year , which is the 1st year to be considered in any set of data. Ex: when comparing financial statements for 2019 & 2020, 2019 is the
chosen base year
• 2. compute the percentage of year to year change for the item to be compared using the formula below:
percentage change = (amount of change/base year amount) X 100
Rules:
• When a negative amount appears in the base and a positive amount in the next period (or vice versa), we cannot compute a meaningful percentage
change EX- net income
• When there is no amount for the base period, no percentage change is computable. EX- notes payable
• when the base period amount is small, a percentage change can be computed but the number must be interpreted with caution. This is because it can
signal a large change merely because of the small base amount used in computing the change. EX- Cash
• when an item has a value in the base period and none in the next period, the decrease is 100%. Ex: notes receivable
 Year to year change analysis
percentage change = (amount of change/base year amount)x 100

1. 16,734-15,564 =
1,170

1. Give 2. 1,170/15,564 x
data 100 = 7.5%

sales

2. Provide
suggestion

First, net sales increased by 7.5% and cost of sales increased by 12.3%, leading to an increase in Colgate’s gross profit of 4.2%,
which is lower than its revenue increase. This suggests that Colgate is operating with increasing production costs, which are lowering Colgate’s gross
profit margin on each sale. Selling, general, and administrative expenses increased by 6.4%. In its MD&A
3.Refer
section, Colgate management notes that while selling, general, and administrative costs have increased over the year, this increase is lower than the to
increase in revenue, which serves to increase its profit margin on sales. Colgate attributes this shift in selling, general, and administrative costs to other
slightly higher advertising spending that is partially offset by cost saving initiatives. Colgate’s R&D increased slightly since 2009, indicating a stable
source
amount of investment in R&D. Pretax income increased by 10.5% and income tax expense increased at nearly the same rate by 10.6%, thereby leading
to an increase in net income of 10.4%. In sum, Colgate is performing well in a tough competitive environment
10
4. conclusion
 Clover, Inc.
Comparative Balance Sheets
December 31,
Percent
2011 2010 Dollar Change Change*
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 $ (11,500) ?
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets $ 155,000 $ 164,700
Property and equipment: $12,000 – $23,500 = $(11,500)
Land 40,000 40,000
Buildings and equipment, net 120,000 85,000
Total property and equipment $ 160,000 $ 125,000
Total assets $ 315,000 $ 289,700
* Percent rounded to one decimal point.
 Clover, Inc.
Comparative Balance Sheets
December 31,
Percent
2011 2010 Dollar Change Change*
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 $ (11,500) -48.9%
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets $ 155,000 $ 164,700
($11,500 ÷ $23,500) × 100% = 48.94%
Property and equipment:
Land 40,000 40,000
Buildings and equipment, net 120,000 85,000 Complete the
Total property and equipment $ 160,000 $ 125,000
Total assets $ 315,000 $ 289,700
analysis for
* Percent rounded to one decimal point. the other
assets.
 Clover, Inc.
Comparative Balance Sheets
December 31,
Percent
2011 2010 Dollar Change Change*
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 $ (11,500) -48.9%
Accounts receivable, net 60,000 40,000 20,000 50.0%
Inventory 80,000 100,000 (20,000) -20.0%
Prepaid expenses 3,000 1,200 1,800 150.0%
Total current assets $ 155,000 $ 164,700 (9,700) -5.9%
Property and equipment:
Land 40,000 40,000 - 0.0%
Buildings and equipment, net 120,000 85,000 35,000 41.2%
Total property and equipment $ 160,000 $ 125,000 35,000 28.0%
Total assets $ 315,000 $ 289,700 $ 25,300 8.7%
* Percent rounded to one decimal point.
 Index trend number analysis
• To focus on significant items only, no need to analyze every item in financial
statements

• We also must exercise care in using index-number trend comparisons where changes might
be due to economy or industry factors.
• Moreover, interpretation of percentage changes, including those using index-number trend
series, must be made with an awareness of potentially inconsistent applications of
accounting principles over time. When possible, we adjust for these inconsistencies.
• Also, the longer the time period for comparison, the more distortive are effects of any
price-level changes. One outcome of trend analysis is its power to convey insight into
managers’ philosophies, policies, and motivations. The more diverse the environments
constituting the period of analysis, the better is our picture of how managers deal with
adversity and take advantage of opportunities.
Trend Percentages –index number trend
analysis

Trend analysis is used to reveal patterns in

data covering successive periods.

Trend Analysis Period Amount

= × 100%
Percentages Base Period Amount
 320,000/275,000 x
Trend Percentages 100 = 116%
Please
calculate for
every year Berry Products
Income Information
For the Years Ended December 31,
Item 2011 2010 2009 2008 2007
Revenues $400,000 $355,000 $320,000 $290,000 $275,000
Cost of sales 285,000 250,000 225,000 198,000 190,000
Gross profit 115,000 105,000 95,000 92,000 85,000
Item 2011 2010 2009 2008 2007
Revenues 145% 129% 116% 105% 100%
Cost of sales 150% 132% 118% 104% 100%
Gross profit 135% 124% 112% 108% 100%

(290,000  275,000)  100% = 105%

(198,000  190,000)  100% = 104%
(92,000  85,000)  100% = 108%
Example: Index-number Trend Analysis

Using Year 3 as the base year, compute an index-

number trend series for:
• Sales
• Cost of goods sold
• Gross profit
• Marketing and administrative costs
• Operating income
• Net income

17
Example: Index-number Trend Analysis

YES MANUFACTURING SENDIRIAN BERHAD

Consolidated Income Statements
30 June, Year 5, Year 4 and Year 3
Year 5 Year 4 Year 3
Net sales RM1,684,00 RM1,250,00 RM1,050,00
0 0 0
Cost of goods sold (927,000) (810,000) (512,000)
Gross profit 757,000 440,000 538,000
Marketing and administrative (670,000) (396,700) (467,760)
cost
Operating income 87,000 43,300 70,240
Interest cost (12,000) (7,300) (2,240)
Earnings before income tax 75,000 36,000 68,000
Income tax (30,000) (14,000) (28,000)
Net income RM 45,000 RM 21,600 RM 40,000

18
Example: Index-number Trend Analysis

Index-number trend series Year 5 Year 4 Year 3

Sales 160.4 119.0 100.0
Cost of goods sold 181.1 158.2 100.0
Gross profit 140.7 81.8 100.0
Marketing and administrative 143.2 84.8 100.0
Net income 112.5 54.0 100.0

• Sales (Y4) = (1,250,000/1,050,00) x 100 = 119

19
Trend percentages (index trend analysis)

Sales increased over the period from 2006 to 2011, but this increase in sales
slowed over the 2008-2010 period. Over this period, Colgate was able to slow the
increase in operating expenses to maintain growth in net income over the period
Vertical analysis

21
Component Percentages
Examine the relative size of each item in the financial
statements by computing component
(or common-sized) percentages.

Component Analysis Amount

Percentage
= Base Amount × 100%

Financial Statement Base Amount

Balance Sheet Total Assets
Income Statement Revenues
 Clover, inc.
Comparative Balance Sheets
December 31,
Complete the common-size analysis for the other Common-size
assets. Percents*
2011 2010 2011 2010
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 3.8% 8.1%
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets $ 155,000 $ 164,700
($12,000 ÷ $315,000) × 100% = 3.8%
Property and equipment:
Land 40,000 40,000
Buildings and equipment, net ($23,500120,000 85,000
÷ $289,700) × 100% = 8.1%
Total property and equipment $ 160,000 $ 125,000
Total assets $ 315,000 $ 289,700 100.0% 100.0%
* Percent rounded to first decimal point.
 Clover, Inc.
Comparative Balance Sheets
December 31,
Common-size
Percents*
2011 2010 2011 2010
Assets
Current assets:
Cash and equivalents $ 12,000 $ 23,500 3.8% 8.1%
Accounts receivable, net 60,000 40,000 19.0% 13.8%
Inventory 80,000 100,000 25.4% 34.6%
Prepaid expenses 3,000 1,200 1.0% 0.4%
Total current assets $ 155,000 $ 164,700 49.2% 56.9%
Property and equipment:
Land 40,000 40,000 12.7% 13.8%
Buildings and equipment, net 120,000 85,000 38.1% 29.3%
Total property and equipment $ 160,000 $ 125,000 50.8% 43.1%
Total assets $ 315,000 $ 289,700 100.0% 100.0%
* Percent rounded to first decimal point.
 Clover, Inc.
Comparative Income Statements
For the Years Ended December 31,
Common-size
Percents*
2011 2010 2011 2010
Revenues $ 520,000 $ 480,000 100.0% 100.0%
Costs and expenses:
Cost of sales 360,000 315,000 69.2% 65.6%
Selling and admin. 128,600 126,000 24.7% 26.3%
Interest expense 6,400 7,000 1.2% 1.5%
Income before taxes $ 25,000 $ 32,000 4.8% 6.7%
Income taxes (30%) 7,500 9,600 1.4% 2.0%
Net income $ 17,500 $ 22,400 3.4% 4.7%
Net income per share $ 0.79 $ 1.01
Avg. # common shares 22,200 22,200
* Rounded to first decimal point.
Diff between comparative (horizontal) & common
size (vertical) analysis- in Microsoft word

https://keydifferences.com/difference-between-horizontal-
and-vertical-analysis.html
Horizontal analysis vs. vertical analysis
Altogether, there are a few main similarities between horizontal analysis and vertical analysis,
including:
•Both horizontal and vertical analysis can be used by internal and external stakeholders.
•Both forms of analysis can help you pick out trends and patterns in financial data and
develop strategies.
•Both forms of analysis can help you analyze various financial statements, including balance
sheets and income statements.

However, there are also some differences between the two that are important to understand.
The primary differences between horizontal and vertical analysis include:
•Horizontal analysis is performed horizontally across time periods, while vertical analysis is
performed vertically inside of a column.
•Horizontal analysis represents changes over years or periods, while vertical analysis
represents amounts as percentages of a base figure.
•Horizontal analysis usually examines many reporting periods, while vertical analysis typically
focuses on one reporting period.
•Horizontal analysis can help you compare a company's current financial status to its past
status, while vertical analysis can help you compare one company's financial status to
another's.
 Example: Vertical Common-Size Analysis

Year 2008 2009 2010 2011 2012 2013

Cash 6% 6% 5% 5% 5% 5%
Inventory 23% 23% 23% 23% 22% 22%
Accounts receivable 16% 16% 16% 15% 15% 15%
Net plant and equipment 50% 50% 51% 51% 52% 52%
Intangibles 6% 6% 5% 5% 5% 5%
Total assets 100% 100% 100% 100% 100% 100%
Graphically:
100%

Proportion 50%
of Assets

0%
2008 2009 2010 2011 2012 2013
Fiscal Year

Cash Inventory Accounts receivable Net plant and equipment Intangibles

29
 Example: Horizontal Common-Size Analysis (base year
is 2008)

Year 2008 2009 2010 2011 2012 2013

Cash 100.00% 101.00% 102.01% 103.03% 104.06% 105.10%
Inventory 100.00% 103.00% 106.09% 109.27% 112.55% 115.93%
Accounts receivable 100.00% 102.00% 104.04% 106.12% 108.24% 110.41%
Net plant and equipment 100.00% 104.00% 108.16% 112.49% 116.99% 121.67%
Intangibles 100.00% 100.50% 101.00% 101.51% 102.02% 102.53%
Total assets 100.00% 103.08% 106.27% 109.57% 112.99% 116.53%
Graphically:
130%
Percentage 120%
of Base
110%
Year
Amount 100%
90%
2008 2009 2010 2011 2012 2013
Fiscal Year
Cash Inventory Accounts receivable Net plant and equipment Intangibles Total assets

30
Common Size Balance Sheets

31
Common Size Income Statements

32
EXERCISES TOPIC 4 COMPARATIVE &
COMMON SIZE ANALYSIS
34
The analysis of financial ratios
1. Trend analysis
2. Cross-sectional analysis
3. Combined analysis
4. Rule of thumb analysis
 TREND ANALYSIS
• Assess performance over time
• Provides information about changes, patterns or progress in the financial performance of a firm for several successive
years
• Compares a particular financial ratios over a few years (ex: 5 year period)
• Past year performance can be used as a benchmark to evaluate current year performance
• Analysts can identify any material year to year changes in a specific aspect of financial ratio or performance, which may
be a signal to a greater problem in the firm, particularly when the industry does not show a similar trend
• Limitations:
• One should not expect that past performance can predict future performance. Can only serve as an indicator of the
effectiveness of the management in managing the form
• Not helpful in judging the performance of a firm relative to its competitors or industry
Take home exercise
• Problem 1.2
• Problem 1.4