What is / are the biggest advantages of using horizontal analysis (using %s of t
ID: 2464987 • Letter: W
Question
What is / are the biggest advantages of using horizontal analysis (using %s of the total) and common sized statements AND using ratios like the quick ratio and debt to equity ratio in analyzing financial statements? For example, in this week’s Excel homework problem, how could computing the raios for BOTH years, and using horizontal analysis and common sized statements help us to compare the two years AND compare this company to two similar (same industry) companies, but one of which is 2.5X the size, while the other is only 60% the size of “our” company?
Explanation / Answer
The advantages if horizontal analysis is that the trend analysis of an item can be done. This analysis shows the % by which the amount of an element of financial statement has changed over years. This gies a clear idea how the company performs in that articular element and what action should be taken to enhance or control that performance.
The common sized statement using vertical analysis and the ratios like quick ratios and D/E ratio are useful in nalysing the performance of companies having different size in the same industry, As the elements are expressed as % of total assets or total sales or as ratios , the comparison involving different scale of revenue remains relevant. This is very useful tool for intercompany comparison without any adjustment for the volume of operations.
Given below an example of horizontal analysis where the sales data of two years for the same company have been compared to find the trend of increase in sales.
Given below a sample of vertical analysis of three companies in the same industry one industry having 2.5 x revenue and another 60% size of our company. The vertical analysis in term of COGS & Gross Profit as % pf sales gives a clear comparison of three firms performance , though their size of opeartions are different.
Company X Horizontal Analysis of sales Year 2012. Year 2011. Annual Sales 150,000 120,000 Trend 125% 100%Related Questions
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