FSS: COMPARATIVE & COMMON SIZE ANALYSIS OF FINANCIAL STATEMENTS

Md. Mahabbat Hossain Lecturer, BIBM

Introduction
Analyzing financial statements involves evaluation three characteristics of a company: its liquidity, its profitability and its solvency. For example, a short-term creditor, such as a bank, is primarily interested in the ability of the borrower to pay obligations when they come due. The liquidity of the borrower in such a case is extremely important in evaluation the safety of a loan. A long-term creditor, such as a bondholder, however, looks to indicators such as profitability and solvency that indicate the firms ability to survive over a long period of time. Similarly, stockholders are interested in the profitability and solvency of the enterprise when they assess the likelihood of dividends and the growth potential of the stock.

Financial Statements Analysis

Financial statement analysis consists of applying analytical tools and techniques to financial statements and other relevant data to obtain useful information. This information reveals significant relationships between data and trends in those data that assess the companys past performance and current financial position. The information shows the results or consequences of prior management decisions. In addition, analysts use the information to make predictions that may have a direct effect on decisions made by users of financial statements. A financial statement is a collection of data organized according to logical and consistent accounting procedures. It's purpose is to convey an understanding of some financial aspects of a business firm. Financial statements are the major means employed by firms to present their financial situation to stockholders, creditors and the general public. The majority of firms include extensive financial statements in their annual reports, which receive wide distribution. Every item reported in a financial statement has significance. It is necessary to compare each item of financial statement with other financial statement data. Comparisons can be made on a number of different bases. Such as: 1) Intra-company basis: This basis compares an items or financial relationship within a company in the current year with the same item or relationship in one or more prior years. 2) Industry averages: It compares an item or financial relationship of a company with industry averages published by financial rating organizations. 3) Inter-company basis: This basis compares an item or financial relationship of one company with the same item or relationship in one or more competing companies.

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Tools of Financial Statement Analysis

Various tools are used to evaluate the significance of financial statement data. Three commonly used tools are these;

1. Horizontal Analysis
Horizontal analysis is called trend analysis. It is a technique for evaluating a series of financial statement data over a period of time. It is used primarily in intra-company comparisons. Its purpose is to determine the increase or decrease that has taken place, expressed as either an amount or a percentage. Current Year Amount Base Year Formula to calculate = Amount change Base Year Amount Two features in published financial statements facilitate this type of comparison: First, each of the basic financial statements is presented on a comparative basis for a minimum of two years. Second, a summary of selected financial data is presented for a series of 5 to 10 years or more.

2. Vertical Analysis
Vertical analysis is a technique for evaluating financial statement data that expresses each item in a financial statement in terms of a percent of a base amount. Sometimes it is referred to as common size analysis. The value of total assets is used as the base amount for balance sheet items and the value of sales for income statement items. Vertical analysis is used in both intra-company and inter-company comparison.

3. Ratio Analysis
Ratio analysis expresses the relationship among selected items of financial statement data. A ratio expresses the mathematical relationship between one quantity and another. Financial ratios are designed to help one to evaluate financial performance of a firm. By observing financials at a glance one cannot immediately understand the actual financial condition of a firm i.e. whether the financial condition of the firm is improving or not. Ratio analysis is used in all three types of comparison; intracompany, inter-company and industry average. Ratio can be expressed as a percentage, rate or simple proportion. Fundamental classification of Ratio: 1. Growth Ratio 2. Profitability Ratio
4. Activity Ratio 5. Liquidity Ratio and

3. Coverage Ratio
6. Leverage Ratio

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