Accounting and Finance Foundations

Unit 11

Accounting and Finance Foundations Unit 11: Financial Analysis 823

Financial Analysis

Lesson 23.1

Chapter 23

Student Guide

Financial statement analysis involves more than “crunching numbers.” Before you can start looking at

numbers, you have to know what you are looking for. While financial statements report on transactions,

each of those transactions is the result of a company’s operating decisions as it implements its business

strategy.

The best place to start financial analysis is with a solid understanding of a company’s business strategy.

To evaluate how well a company is doing, you must know the manager’s and owner’s objectives to have a

basis for comparison. For example, would you be impressed with a company that earned $1 million last

year? You are probably thinking, “It depends.” A $1 million profit might be very good for a company that

lost money the year before but not good for a company that made $500 million the preceding year. Like-

wise, that amount of profit might be good for a small company but not for a large company.

Financial results cannot be evaluated in isolation. To properly analyze the information reported in financial

statements, you must develop appropriate comparisons. There are four methods for making financial com-

parisons: horizontal, vertical, ratio, and industry analyses.

Horizontal Analysis

Horizontal analysis: The percentage analysis of increases and decreases in related items in comparative

financial statements. The amount of each item on the most recent statement is compared with the related

item on one or more earlier statements. The amount of increase or decrease in the item is listed, along with

the percent of increase or decrease.

Business

Strategy

Operating

Decisions

Transactions Financial

Statements