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Financial statement analysis and interpretation
Financial statement analysis and interpretation

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2 Types of financial statement analyses

There are three main techniques that help users build an opinion about the financial strength and performance of a business: ratio analysis, vertical analysis (also known as common size analysis) and horizontal analysis.

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Figure 4 There are three different types of financial statement analyses
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A figure explaining the meaning and functions of vertical, horizontal and ratio analyses.

In the Ratio Analysis column are three texts with an arrow pointing from one to the next: 1. Ratio analysis puts numbers in perspective with other numbers; 2. Ratio analysis removes the importance of company size in analysing numbers; 3. Ratios provide meaningful relationships between individual financial values in the financial statements.

In the Vertical analysis column are three texts with an arrow pointing from one to the next: 1. Vertical analysis shows relationship of each item in financial statement to one base amount; 2. In income statement each item is shown as a percentage of sales; 3. In statement of financial position each item shown as a percentage of total assets.

In the Horizontal analysis column are two texts with an arrow pointing from one to the next: 1. Horizontal analysis compares two financial statements to calculate percentage changes; 2. Horizontal analysis removes the importance of company size in analysing numbers.

Figure 4 There are three different types of financial statement analyses

There are other types of analyses as well, such as segmental analysis and historical summaries, which may help users to gain a holistic understanding of a business.