492 Chapter 12 Financial Statements
Sammy’s Lemonade Stand
Second Quarter 2007 Income StatementDollars Percent of SalesNet sales $185.25 100.00%
Cost of goods sold
Lemons $34.60 18.68%
Sugar $12.25 6.61%
Cups $20.15 10.88%
Other $8.35 4.51%
To tal cost of goods sold $75.35 40.67%
Gross profi t $109.90 59.33%
Overhead
Advertising $12.00 6.48%
Wages $31.00 16.73%
Other $2.00 1.08%
To tal overhead $45.00 24.29%
Net income $64.90 35.03%Having these percentages readily available can be very helpful in analyzing a business’s
performance. We can, for example, see that Sammy’s gross profit is 59.33% of sales (this
percent is called his gross profit margin). If he knows that other neighborhood lemonade
stands run at a 60% gross profit margin, he can see that he is doing about as well in that
regard as others are. Similarly, if he sees that his overhead of 24.29% is much lower than
an average of 40% for other similar businesses, he can conclude that he is managing his
overhead costs well for his type of business. This analysis is much harder to do with the
absolute dollar figures.
Looking at each category’s percentage of the total net sales allows us draw conclusions
about each area in proportion to the total. Since the items being compared are above/below
each other, this is known as a vertical analysis. This sort of analysis can help us to see how
much each piece contributes to the overall picture. It does not, however, tell us much about
the trends in the business, whether things are getting better or worse overall and in each
category.Horizontal Analysis of Income Statements
To be able to see trends in a business’s sales, profits and/or expenses, we might instead
want to look at a financial statement that compares the current period’s results to a prior
period. In that case, we would be more interested in percentages not of the total net sales,
but rather of change from one period to the next. If we set up an income statement showing
the results from the current period next to the results from a prior period to which we want
to compare it, and then calculate the change from one period to the next, we would create
a statement looking something like the one shown on the next page.
Horizontal analysis, so called because the items we are comparing are written next
to each other in horizontal rows, enables us to see trends in the business. We can see that
Sammy dramatically increased his spending on advertising, and this seems to have paid
off in an 11.76% increase in sales. This increase in sales did not entirely translate into an
increase in profits, though. Profits grew by a much more modest 3.92%. Why didn’t profits
grow as quickly as sales? There must have been an increase in some of the business’s costs.
Horizontal analysis helps spot where those cost increases came from. In addition to the
increase in advertising spending, Sammy’s cost for lemons shot up by $12.55, a 56.92%
increase. Other costs stayed fairly stable, or decreased, so Sammy can readily identify
which areas may require more attention as he manages his business.
An income statement may show both the horizontal period-to-period comparisons and
vertical percent of sales comparisons. An example of a statement that includes this appears
below.