Jay Rich (2009) explained two methods in financial statement analysis that are commonly used. Which are:
- Horizontal and vertical analysis
- Use of ratios
Horizontal/trend analysis is a technique that checks changes of financial data over a series of reporting periods. It is important in finding out the trend within a specific period. Vertical analysis, on the other hand, analyses financial statements in proportions (expressed as percentages) for example % gross sales in the income statement and % total assets in the balance sheet.
The major difference between horizontal and vertical analysis is that horizontal looks at multiple periods while vertical focuses on a single period.
Use of ratios compares a figure against another in the financial statement. Calculated ratios can be compared to periods in the past or other company’s ratios to make a decision on the company. Examples of ratios include liquidity ratios, activity ratios, leverage ratios and profitability ratios.
Several issues arise when conducting analysis of financial statement (Accounting Tools, 2016):
- Activities in the business constantly change within and when evaluating financial statements from one period to the next, results may vary significantly.
- Financial statement analysis in an industry by different companies that vary in size and complexity are done differently. In an attempt to compare between different businesses, the analysis may not be accurate and provide misleading information to decision makers.
- A holistic representation of the business is not done through the financial statement analysis as it focuses on finances and neglects operational information.