Question

Describe the three types of financial statement analysis. How do you do them? What do they tell you? Which method provides the best information to the entrepreneur? Justify your answer.

Answer 1

The three types of financial statement analysis are:

- Horizontal analysis- This analysis is used by companies to compare two or more years’ financial statements. The same information is just compared by reading across the different pages however the years differ. The dollar differences from year to year are easily found out by analysts.

- Vertical analysis- the company’s financial figures are listed vertically on the financial statement for analysis. That is why it is called vertical analysis. The analyst calculates the percentages of each financial statement. The financial statements that are used to obtain this percentage are Balance Sheet and Income Statement.

- Ratio Analysis- There different types of rations. Analysts calculate ratios for each financial year from the financial data. Then, the ratio is used to find relationship between variables or the trend over the past years. For example, Balance Sheet ratio analysis is used to determine the company’s ability to pay off the debts (liabilities) and how much the company is dependent on its creditors to pay off the bills.

Ratio Analysis provides the best information to the entrepreneur because the financial position of the company can be analyzed and further relationship with the other variables can be obtained. This is not possible in the other two financial analysis. Relationship finding is important for the success of the business as it helps the company to plan for the future and develop strategies accordingly.