Module 05 (Q1-Week 6): Analysis and Interpretation of Financial Statements 1 -

Horizontal Analysis and Vertical Analysis

I. LEARNING COMPETENCIES
1. Perform vertical and horizontal analyses of financial statements of a single
proprietorship.
2. Solve exercises and problems that require computation and interpretation using
horizontal analysis and vertical analysis.
3. Perform horizontal and vertical analysis using the downloaded sample financial
statements.

II. LESSON PRESENTATION

Motivation
Imagine you are a business owner. Write the business you have in mind on the blank:

As business owner, do you think the following questions are significant to you? Write a
short insight on the blanks below.
What is the asset growth for the year?
Is the asset composition for this year the same as last year?
Is the revenue growth this year better than last year?
Is the net income growth this year better than last year?
How much cash can I withdraw from my business not compromising the ability to pay business'
debts?

Such questions above are very important. These questions can be answered by the
process called Financial Statement (FS) Analysis.
Financial Statement (FS) Analysis - is the process of evaluating risks, performance, financial
health, and future prospects of a business by subjecting financial statement data to
computational and analytical techniques with the objective of making economic decisions
(White et.al 1998). There are three kinds of FS analysis techniques:
- Horizontal analysis
- Vertical analysis
- Financial ratios
To Note: In this module we will focus on horizontal and vertical analysis. The financial ratios will be discussed on
the next module.

Horizontal Analysis - also called trend analysis, is a technique for evaluating a series of financial
statement data over a period of time with the purpose of determining the increase or decrease
that has taken place (Weygandtet.al 2013). This will reveal the behavior of the account over
time. Is it increasing, decreasing or not moving? What is the magnitude of the change? Also,
what is the relative change in the balances of the account over time?
1
- Horizontal analysis uses financial statements of two or more periods.
- All line items on the FS may be subjected to horizontal analysis.
- Only the simple year-on-year (Y-o-Y) grow this covered in this lesson.
- Changes can be expressed in monetary value (peso) and percentages computed by using the
following formulas:
• Peso change=Balance of Current Year-Balance of Prior Year
• Percentage change= (Balance of Current Year-Balance of Prior Year)/(Balance of Prior
Year)
Example:

Image 5.1. Sample Horizontal Analysis (Source: DepEd FABM 2 Teaching Guide)
Peso change = P250,000 - P175,000 = P75,000
Percentage change = (P250,000 - P175,000) / P175,000 = 42.86%
This is evaluated as follows:
Sales increased by P75,000. This represents growth of 42.86% from 2013 levels.

Vertical Analysis - also called common-size analysis, is a technique that expresses each financial
statement item as a percentage of a base amount (Weygandt et.al. 2013).
For the SFP, the base amount is Total Assets.
• Balance of Account / Total Assets.
• From the common-size SFP, the analyst can infer the composition of assets and the
company’s financing mix.
Example:

Image 5.2. Sample Vertical Analysis (Source: DepEd FABM 2 Teaching Guide)
The above may be evaluated as follows:
The largest component of asset is Equipment at 39.3%. Cash is the smallest component at 14%.
On the other hand, 50% of assets are financed by debt and the other half is financed by equity.
For the SCI, the base amount is Net Sales.
• Balance of Account / Total Sales.

2
 • This will reveal how “Net Sales” is used up by the various expenses.
• Net income as a percentage of sales is also known as the net profit margin.
Example:

Image 5.3. Sample Horizontal Analysis (Source: DepEd FABM 2 Teaching Guide)
The above may be evaluated as follows:
• The cost of goods sold is 44% of sales. The company has a gross profit rate of 55.5%.
Operating expenses is 22% of sales.
• The company earns income of P 0.33 for every peso of sales. Gross profit generated for every
peso of sale is P 0.555.
The use of common-size financial statements allows the comparison of two companies
of different sizes. This is because the SFP and SCI comparative information are standardized as a
percentage of assets and sales, respectively.

III. SUMMARY OF LESSON

 Financial Statement (FS) Analysis is the process of evaluating risks, performance, financial
health, and future prospects of a business by subjecting financial statement data to
computational and analytical techniques with the objective of making economic decisions.
 Horizontal Analysis or trend analysis, is a technique for evaluating a series of financial
statement data over a period of time.
 Vertical Analysis or common-size analysis, is a technique that expresses each financial
statement item as a percentage of a base amount.

IV. PRACTICE
Preparation of Vertical and Horizontal Analyses
Direction: Make a vertical and horizontal analyses on the SFP and SCI below. Write on a separate sheet
or you can use a spreadsheet. (2 pts. each)

3
 2013

Then evaluate the ff.: (2 pts. each)

a. Growth of sales
b. Largest and smallest component of assets
c. Assets financed by debt and assets financed by equity
d. Cost of goods sold as to sales, gross profit rate, operating expenses as to sales
e. Income per peso sales, gross profit per peso sales

4
V. ENRICHMENT
Direction: Refer to JFC 2013 and 2014 audited SFP and SCI on the next pages. Answer briefly the
questions below. Show your solution for questions requiring computation. Answer on a
separate sheet. (2 pts. each)
1. What is the asset growth in 2014?
2. Is the asset composition in 2014 the same as that in 2013?
3. Compare the financing mix (portion of assets financed by debt and equity, respectively) of
JFC in 2014 and 2013 and determine if there is a significant change.
4. Is the revenue growth in 2014 better than that in 2013?
5. Is the net income growth in 2014 better than that in 2013?

5
6
7
8
9
VI. EVALUATION
A. Multiple Choice
Direction: Choose the letter of the correct answer. Show your solutions. Answer on a separate
sheet. (2 pts. each)
1. If current assets are ₱270,000 and total assets are ₱810,000, what percentage of total assets
are current assets?
a. 3.5 percent
b. 30 percent
c. 25 percent
d. 33 percent
2. Comparing the amount of a balance sheet item in one year to the amount for the same item
in a prior year is called
a. common-size analysis
b. vertical analysis
c. horizontal analysis
d. ratio analysis
3. A firm has liabilities of ₱30,000 and owner’s capital of ₱90,000. The percentage of total
liabilities to total assets is
a. 25 percent
b. 20 percent
c. 50 percent
d. 75 percent
4. A firm had owner’s capital of ₱150,000 in 2013 and ₱187,500 in 2013. The increase in
owner’s capital from 2013 to 2014 is
a. 12.5 percent
b. 20 percent
c. 25 percent
d. 125 percent
5. If long-term liabilities are ₱300,000 and total assets are ₱2,100,000, what percentage of total
assets are long-term liabilities?
a. 7 percent
b. 16.7 percent
c. 12.5 percent
d. 14.3 percent

B. Preparation of Vertical and Horizontal Analyses

Direction:
a. Prepare a common-size Statement of Financial Position for 2014 and 2013 for Ilang-
Ilang Trading Company. (2 pts. each)
b. Prepare a horizontal analysis for Ilang-Ilang Trading Company. (2 pts. each)
Answer on a separate sheet.

10
C. Critical Thinking
Direction: Provided below are the financial statements of FGHI Company Ltd. Compare the
profit performance and financial position of FGHI Company Ltd. with the average of the
industry. Prepare the common size financial statements on a separate sheet and compare your
results with the industry average. Write your comparison on a separate sheet in paragraph
form of 5-10 sentences. (2 pts. each for the values) (10 pts for comparison; 7 - Accuracy of
Ideas, 3 - Organization of Ideas)

11
VII. RESOURCES
DepEd FABM 2 Teaching Guide
http://www.accounting-basics-for-students.com/statement-of-owners-equity.html#gallery[pageGallery]/2/
https://www.jollibee.com.ph/investors/jollibee-foods-corporation/

12