HORIZONTAL ANALYSIS

FINANCIAL ANALYSIS VERTICAL ANALYSIS

RATIO ANALYSIS
Horizontal Analysis
• is the comparison of historical financial information over a series of
reporting periods, or of the ratios derived from this information.
• It is used to see if any numbers are unusually high or low in
comparison to the information for bracketing periods, which may
then trigger a detailed investigation of the reason for the difference.
• It can also be used to project the amounts of various line items into
the future. The analysis is most commonly a simple grouping of
information that is sorted by period, but the numbers in each
succeeding period can also be expressed as a percentage of the
amount in the baseline year, with the baseline amount being listed as
100%.
Vertical Analysis
• is a method of financial statement analysis in which each line item is
listed as a percentage of a base figure within the statement.
• Line items on an income statement can be stated as a percentage
of gross sales,
• while line items on a balance sheet can be stated as a percentage of
total assets or liabilities,
• and vertical analysis of a cash flow statement shows each cash inflow
or outflow as a percentage of the total cash inflows.
RATIO ANALYSIS
• a quantitative method of gaining insight into a company's liquidity,
operational efficiency, and profitability by comparing information
contained in its financial statements.
• Used to measure financial performance against standards.
• Analysts compare these ratios to industry averages (benchmarking),
industry standards or rules of thumbs and against internal trends
(trends analysis).
• The most useful comparison when performing financial
ratio analysis is trend analysis. They are derived from the three
following financial statements:
• Balance Sheet Income Statement Statement of Cash Flows
5 Major Categories of Financial Ratios

Liquidity Ratios
Activity Ratios
Debt Ratios
Profitability Ratios
Market Ratios
 LIQUIDITY RATIO
• 1. What is liquidity ratio?
• It’s a ratio which tells one’s ability to pay off its debt as and when they
become due. In other words, we can say this ratio tells how quickly a
company can convert its current assets into cash so that it can pay off
its liability on a timely basis. Generally, Liquidity and short-term
solvency are used together.

• 2. Why Liquidity ratio?

• Liquidity ratio affects the credibility of the company as well as the
credit rating of the company. If there are continuous defaults in
repayment of a short-term liability then this will lead to bankruptcy.
Hence this ratio plays important role in the financial stability of any
company and credit ratings.
 LIQUIDITY RATIO
• 3. Formulas
• Under liquidity ratio there are several more ratios, which come into
the picture for checking how financially, sound a company is:
• I. Working Capital Ratio
• II. Current Ratio Working Capital Ratio
• III. Acid Test Ratio or Quick Ratio
• IV. Absolute Liquidity Ratio
 Working Capital Ratio
• "Working capital" is the money you need to support short-
term operations. It is this focus on the short term that distinguishes
working capital from longer-term investments in fixed assets or R&D.

• Working capital is the difference between current assets and current

liabilities.
Current Ratio
• The current ratio is a liquidity ratio that measures a company's ability
to pay short-term obligations or those due within one year. It tells
investors and analysts how a company can maximize the current
assets on its balance sheet to satisfy its current debt and other
payables.
• In general, the higher the ratio, the greater your flexibility to expand
operations. If the ratio is decreasing, you need to understand why.
The ideal ratio depends on your industry and particular
circumstances. If it is less than 1:1, this usually means you are
finding it hard to pay bills. Even when the ratio is higher than 1:1,
you may have difficulty, depending on how quickly you can sell
inventories and collect accounts receivable. A ratio of 2:1 usually
provides a reasonable level of comfort.
QUICK RATIO/ACID TEST RATIO
• compares the total amount of cash and cash equivalents + marketable
securities + accounts receivable to the amount of current liabilities.
• The quick ratio differs from the current ratio in that some current
assets are excluded from the quick ratio. The most significant current
asset that is excluded is inventory. The reason is that inventory might
not be "quick" to turn to cash.
• Quick assets are current assets that can be converted to cash within
90 days or in the short-term. = Cash, cash equivalents, short-term
investments or marketable securities, and current accounts
receivable
What Are Solvency Ratios Good For?

Solvency ratios are of interest to long-term creditors and shareholders.

These groups are interested in the long-term health and survival of
business firms. In other words, solvency ratios have to prove that business
firms can service their debt or pay the interest on their debt as well as pay
the principal when the debt matures.

Solvency ratios also help the business owner keep an eye on downtrends
that could eventuate in a possible bankruptcy. As the debt/asset ratio
increases, the likelihood of bankruptcy also increases as the firm is
financed more and more with debt as opposed to equity sources.
1. The Total Debt/Total Assets Ratio measures how much of the firm's
asset base is financed using debt. If a firm's debt ratio is .5, that means for
every dollar of debt there are two asset dollars, or, putting it another way,
that the firm's equity totals twice its debt.
2. The Equity Ratio explains how much of the company is owned by its
investors. The Equity Ratio is calculated by dividing total equity by total
assets. It answers a basic but very important question: If the company goes
out of business after it pays all liabilities, how much will be left for its
investors?
3. Interest Earned measures a company's ability to meet its long-term debt
obligations. It's calculated by dividing corporate income before interest and
income taxes (commonly abbreviated EBIT) by interest expense related to
long-term debt.
 PROFITABILITY RATIOS
• Profitability ratios are financial metrics used by analysts and investors
to measure and evaluate the ability of a company to generate income
(profit) relative to revenue, balance sheet assets, operating costs, and
shareholders’ equity during a specific period of time. They show how
well a company utilizes its assets to produce profit and value to
shareholders.
• A higher ratio or value is commonly sought-after by most companies,
as this usually means the business is performing well by generating
revenues, profits, and cash flow. The ratios are most useful when they
are analyzed in comparison to similar companies or compared to
previous periods.