Quiz 14: Financial Statement Analysis
Common size income statement It refers to the income statement in which figures are expressed in the form of percentage. This type of financial statement helps in comparing the financial data among of different companies. 1.In the present case the sales of all the three companies are considered as base in order to calculate the percentages. Common size income statement for A Inc., B Inc., and WS Inc. is shown below. 2.On the basis of common size statement the B Inc. is earning far better than A Inc and WS Inc. because the income from operation as compare to sales for B Inc is 17% which is highest among all other enterprises. Further the selling cost of B Inc is lowest in comparison of A Inc and WS Inc.
Horizontal analysis: It involves comparison of each figure in the financial statements with the previous year's figure or over the period of years. This kind of comparison assists in identification of the trends of various items of financial statements like the sales, cost of goods sold administrative expenses et cetera. In the present case, accounts payable and long term debt amounts are available for current year, previous year and the horizontal analysis is executed as below: From the above table, it can be concluded that the company is more inclined towards debt capital and short term borrowings rather than equity. Working Notes: The computation of the values of the figures of the table is provided as under. Therefore, it has computed that the accounts payable has increased by with the amount of . But, the long-term debt has increased by with the amount of .
The financial statements of a company represent the information regarding the financial performance of the company for a period of time and its financial position on a particular date to its users. These users like investors, creditors, suppliers and shareholders of financial information evaluate these financial statements in mainly three areas which are profitability, liquidity and solvency. Liquidity: It means how well the company is able to convert its current assets into cash. For example, the sold inventory would convert into accounts receivable and after that into cash. So, it is the ability of the company to meet the requirement of cash in day-to-day operating activities. Short term creditors, suppliers are always interested in liquidity of the business. For the analysis of liquidity, use the following formula. Simply, it defines the relationship between the current assets and current liabilities of the company. Solvency: It is the ability of the company to pay its long-term creditors like debenture holders, banks both interest amount and the principal of the time period. For the analysis of solvency, use the following formula. Simply, it defines the relationship between the total debt and total equity of the company. Profitability: It is the ability of the company to earn its profit from its operations. The shareholders and investors of the company are vigilant regarding the profitability of the company. As the stock price of the company in the market depends on the current and future earning capability of the company, the profitability ratio provides information about the earning capacity of the firm. For the analysis of profitability, use the following formula. Simply, it defines the relationship between the net income and total assets of the company. Major distinction among the three is related to its content that is current items for the liquidity ratio, income and assets for the profitability ratio and the debt and equity for the solvency ratio. Hence, the analysis of the liquidity, profitability and solvency can be interpreted by the separate computation of the assets, liabilities and equity from the balance sheet of the company.