On the one hand, vertical analysis is used as it reveals the relationship existing between items comprising a balance sheet as well as the bottom line, as they are shown in percentages. An organization’s management can utilize the percentages to set objectives and establish threshold limits. For instance, management may consider eliminating a specific unit in the event profit per one unit drops below a certain threshold percentage (Al-Hashimi, 2019). Apart from that, financial experts use the method due to its usefulness in comparison of the fiscal statement to the average patterns in the sector. It would be unproductive to utilize actual dollar amounts whereas analyzing whole industry. Simple percentages solve such issues and help industry comparisons.
On the other hand, the reason for investors or analysts using horizontal analysis is it helps them to understand what has caused a company to perform in a particular manner over a certain duration. This enables evaluation of relative changes in various line items over specific period and projection of the same into the forthcoming time (Haralayya, 2021). Scrutinizing income and cash flow statements, and balance sheet gives a thorough detail of operational outcomes. It as well shows if an organization is profitable by revealing its performance.
Lessons Learned
The first lesson learned is that for a more straightforward comparison of particular items on a balance sheet, one needs the vertical analysis method as it reveals the relationship between them. The second lesson is that for an investor or analyst to be successful in their work, they need to utilize horizontal analysis which shows patterns in the performance of an organization. This leads to easier determination by the two of a company’s profitability.
Procedure of Comparing Results and Benefit of Ratios Over Dollars
Results can be compared to other companies by using financial ratios. Utilizing ratios enables putting all organizations on an equal playing field before the analysts. Firms are judged using their performance instead of sales volume, market share or size (Kadim et al., 2020). Comparison of the raw fiscal data of two or more organizations in one industry provides inadequate information (Kadim et al., 2020). Ratios determine the companies’ liquidity, operational efficiency, profitability, and stability. This gives investors more relevant data. As suggested earlier, it would not be useful to use actual dollar amounts in analysis of companies or industries.
References
Al-Hashimi, A. (2019). Transparency of government financial reporting: A case study of local government financial reporting in Iraq. International Journal of Innovation, Creativity and Change, 10(6), 372-393. Web.
Haralayya, B. (2021). Financial statement analysis of Shri Ram City Union Finance. Iconic Research and Engineering Journals, 4(12), 183-196. Web.
Kadim, A., Sunardi, N., & Husain, T. (2020). The modeling firm’s value based on financial ratios, intellectual capital and dividend policy. Accounting, 6(5), 859-870. Web.