The two major forms of common-size analysis are horizontal analysis and vertical analysis. What type of information or insights can be obtained by using these two techniques of financial statement analysis? Explain how the output of horizontal analysis and vertical analysis can be compared to industry averages and/or competitive companies
Horizontal analysis allows an analyst to develop a picture of current trends in a company's operations. The analyst can see whether the accounts are increasing or decreasing and how large these changes actually are. Vertical analysis allows an analyst to evaluate financial statement items within a single financial statement. This technique helps the analyst to evaluate the relative size of the financial statement items and how the items relate to the financial statement as a whole. An example would be if current liabilities were a very large percentage of total liabilities and stockholders' equity.
Both techniques allow the company to evaluate their performance and position relative to their competitors and their industry as a whole. For example, the company could evaluate their current trend in sales and see how favorably their sales performance compared to the sales performance of other companies in the industry. Another example would be comparing the relative size of long-term liabilities or retained earnings. This would show which companies have taken on a large amount of debt and which companies have reinvested earnings.
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