Types of financial analysis

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Types of financial analysis

  1. 1. Types of Financial AnalysisFinancial statements are analysed by the users to establish certain crucial relationshipswhich help them to take sound decision by making comparisons. For example,management may analyse the profitability of the business enterprises over a period oftime, to determine the trend of profits and take policy decisions based on profitabilitytrends. Similarly, a prospective investor may analyse the profitability of two or morebusiness enterprises to determine the comparative profitability, the profitability of two ormore business enterprises to determine the comparative profitability. According,following types of analysis are made for financial statement analysis:1. Intra-Firm Comparison: It is a comparison of financial variables of a businessenterprises over a period of time. It analyses the performance of a business over anumber of years and depicts trends of various financial factors. It is very useful formanagement to take various policy decisions. It is also known as Time Series Analysisor Trend Analysis.2. Inter-firm Comparison: It is a comparison of two or more business enterprise. Itanalyse and compares financial variables of two or more concerns to determine thecomparative strength and weaknesses of these enterprises. When single set of statementsof two enterprise are compared, it is known as Cross-Section Anlaysis. Sometimes,financial statements of two or more enterprise are compared over a number of years, thenit is known as Cross-sectional Trend Analysis.3. Industry Average or Standard Analysis: Time series analysis of number offinancial statements of different accounting years of a business enterprises. Cross-sectional analysis involves analysis of financial statements of business enterprise forsame period. There is a third type of financial statement analysis which involves analysisof financial statements of an accounting year of a business enterprise. Only one set offinancial statements of a business enterprise are analysed and financial relationship basedon this statements are compared with the ‘standard’ set for that firm or industry. Forexample, actual profitability as revealed by the analysis of financial statements may becompared with the normal expectations (or standards) in that industry.4. Horizontal Analysis: It refers to analysis of changes in related items incomparative statements. It involves comparison of statements of two or moreperiods/enterprise. Tools used for horizontal analysis are comparative statements, trendstatements, common size statements of two or more enterprises periods.5. Vertical Analysis: It refers to the relationship of each item to the total within asingle statement. For example, each balance sheet item may be expressed as percentageof total assets and income statement items as percentage of net sales. Thus, it makes useof common size statement tools for financial analysis. Unlike horizontal analysis, itshows relationship within a single statement and, that too, in percentage form. Asvertical analysis is restricted to a single statement, it assumes significances only whencomparative common-size statements are prepared. Similarly, calculations of ratios fromfinancial statements of a single accounting year is part of a vertical analysis. Butcomparison of ratios of different periods is a type of horizontal analysis.
  2. 2. Both horizontal and vertical analyses are useful in analysis of trends in financialconditions and operating results of a business. But vertical analysis with both absoluteamount and percentage area also comparing one enterprise with another or with industryaverages. Such comparisons are easy to make with use of common size statements.Distinction between horizontal analysis and vertical analysisHorizontal Analysis Vertical AnalysisIt requires comparative financial statements It requires a single statement of one period.of two or more periods.It provides information in absolute and It provides information in percentage forpercentage form. only.It deals with same item of different periods. It deals with different items of same period.It is generally used for time series analysis It is generally used for cross-section analysis.It is a part of comparisons It is step towards comparisons.

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