Horizontal and Vertical Financial Statement Analysis | Tax Tip of the Week | No. 92

Financial Analysis ToolsLet's digress this week from our typical tax discussion and discuss some tools commonly employed by business owners for analysis of their financial statements and, thusly; their business.  In an earlier week, we explained the importance of financial statement analysis as we must remember the numbers on the financials are not an end in themselves.  And, without trend analysis and common size techniques, it is difficult to draw any meaningful conclusions from them.Most of these financial analysis tools are in the form of either horizontal or vertical analysis.  They are designed to calculate the relationships between various components of the balance sheet and the income statement.Horizontal Analysis (or Trend Analysis) - This tool doesn't have to be any more difficult than laying any of your financial statements beside another period for a “line by line” comparison.  Doing so may quickly highlight trends which are useful for management’s future planning.  One can also compute the percent of the increase or decrease over the beginning number or the base period.  In this calculation the base period equals 100%.  The trend percentage is useful in quantifying the amount, helping to pinpoint and understand the underlying issues that drove the change - whether they are good or bad.  Thusly, we are looking at where we have been, to where we are now, and to where we expect to be in the future.  This information can also be leading indicators of cash needs, inventory requirements, capital asset additions, operating margins and, ultimately, the amount of profitability.Vertical Analysis – This tool “common sizes” your financial statements.  This is necessary so that one can benchmark any size company against another with meaningful results.  The answers may be expressed as percentages, multiples or even number of days – all of which “common size” the results.Some of these ratios may include:(1)  Profitability ratios which measure the results of the business operations.(2)  Liquidity ratios which calculate the short term and long term solvency of the financial position of the business.  These predict the likelihood of whether a business is able to meet short term obligations such as accounts payable and the longer term obligations of debt repayment.(3)  Activity or Turnover ratios compute the efficiency with which the resources of a business have been used. These are often expressed in the number of days that a particular asset is being turned over into sales.Uses of Financial Statement Analysis:A business can analyze its own performance through financial statement analysis.  Investors may evaluate their investments on a company by company basis.  Regulatory authorities can further ensure whether the company is properly following accounting rules. Lastly, financial statement analysis can help the government agencies to analyze the taxation payable to their particular entity.As always, give us a call if you have any questions or need a referral to an estate attorney.This week’s author—Mark Bradstreet, CPAYou can contact us in Dayton at 937-436-3133 and in Xenia at 937-372-3504.  Or visit our website.Rick Prewitt - the guy behind TTW...until next week.