Study_Guide_ch14 - 64817_14_ch14_p467-496 11/7/08 2:47 PM...

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Financial Statement Analysis 14 W HAT Y OU P ROBABLY A LREADY K NOW For years now, you have been a student and have taken many exams. You probably already know that there may be typical responses you have upon receiving your grade. Your first reaction may be the level of satisfaction you have with your grade compared to your previous grades received in that class and the established grading norms for your institution. You may then ask your friends what grade they received so that you can compare your results to them. The instructor may announce the average exam results and you could then determine if you performed better or worse than the average. Students often like to assess their performance by comparing their grade to a standard, their peers, and the average. Businesses often do the same thing. In this chapter, you study various techniques and ratios that a business will use to assess its performance using comparisons to previous results, competitors, and the industry average. Learning Objectives/Success Keys Perform a horizontal analysis of financial statements. Horizontal analysis provides comparisons of financial information over time. To analyze a line item in the financial statements, the difference between the current and earlier time period amounts is computed. The dollar amount change of the line item between the peri- ods is useful, but it is more informative to determine the percentage change by dividing the dollar change (current period amount, or this year’s balance minus earlier period amount, or last year’s balance) by the earlier period amount. Review the horizontal analysis of the income statement and the balance sheet in Exhibits 14-2 and 14-3 (pp. 747–748). Perform a vertical analysis of financial statements. Vertical analysis provides comparisons of individual items on a financial statement to a relative base. The base, which serves as the denominator, is usually net sales for the income statement and total assets for the balance sheet. The vertical analysis percentage is calculated by dividing each financial statement item amount by the relevant base of net sales or total assets.
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468 Chapter 14 | Financial Statement Analysis The vertical analysis percentage is shown next to the item amount on the financial state- ment. Review the vertical analysis of the income statement and the balance sheet in Exhibits 14-4 and 14-5 (p. 750). Prepare and use common-size financial statements. A common-size statement is similar to the vertical analysis but shows only the vertical analysis percentages of each item in the financial statement. This presentation permits ready comparisons between companies of various sizes. Review the common-size com- parison of SmartTouch versus Learning Tree in Exhibit 14-6 (p. 751).
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Study_Guide_ch14 - 64817_14_ch14_p467-496 11/7/08 2:47 PM...

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