Intro to Finance: Financial Statement Analysis - Common-Size Statements, Vertical Analysis Horizontal Analysis

What This Is

Common-size statements, also known as vertical and horizontal analysis, are financial statement analysis techniques used to compare a company's financial performance over time or with industry peers. By expressing each line item as a percentage of a base value, common-size statements help identify trends, anomalies, and areas for improvement. For example, if Apple's net sales in 2020 were $265 billion and in 2021 were $294 billion, the common-size statement would express these numbers as a percentage of net sales, allowing us to see how each line item changed relative to the overall sales growth.

Key Formulas & Symbols

• Vertical Analysis: Expresses each line item as a percentage of a base value, usually net sales or total assets.
• % of Net Sales = (Line Item / Net Sales) × 100
• % of Total Assets = (Line Item / Total Assets) × 100
• Horizontal Analysis: Compares line items over time, usually as a percentage change from the previous period.
• % Change = ((Current Period - Previous Period) / Previous Period) × 100
• Common-Size Statement: A financial statement with each line item expressed as a percentage of a base value.
• Base Value: The value used to express each line item as a percentage, usually net sales or total assets.
• Percentage Change: The percentage change in a line item from the previous period.
• Vertical Analysis Ratio: A ratio that expresses each line item as a percentage of a base value.
• Horizontal Analysis Ratio: A ratio that compares line items over time, usually as a percentage change from the previous period.

Step-by-Step Calculation

1. Gather the necessary financial data, including net sales, total assets, and line items for the current and previous periods.
2. Calculate the base value, usually net sales or total assets.
3. Express each line item as a percentage of the base value using the vertical analysis formula.
4. Calculate the percentage change in each line item from the previous period using the horizontal analysis formula.
5. Analyze the results to identify trends, anomalies, and areas for improvement.
6. Compare the results with industry peers to identify best practices and areas for improvement.

Common Mistakes

• Mistake: Using the wrong base value, such as using total assets instead of net sales.
• Correction: Use the correct base value, usually net sales or total assets, to ensure accurate comparisons.
• Mistake: Failing to account for inflation or other external factors that may affect percentage changes.
• Correction: Adjust for inflation or other external factors to ensure accurate comparisons.
• Mistake: Not considering industry-specific trends or benchmarks when analyzing percentage changes.
• Correction: Research industry-specific trends and benchmarks to ensure accurate comparisons.

Exam / CFA Tips

• Tip: Be prepared to calculate percentage changes and express line items as a percentage of a base value.
• Tip: Understand the differences between vertical and horizontal analysis and when to use each.
• Tip: Be prepared to analyze and interpret common-size statements, including identifying trends and anomalies.

Quick Practice Problem

Problem: Tesla's net sales in 2020 were $24.57 billion and in 2021 were $27.23 billion. What is the percentage change in net sales from 2020 to 2021?

Answer: 10.8% Explanation: ((27.23 - 24.57) / 24.57) × 100 = 10.8%

Last-Minute Cram Sheet

1. Vertical Analysis: Expresses each line item as a percentage of a base value.
2. Use the correct base value to ensure accurate comparisons.
3. Horizontal Analysis: Compares line items over time, usually as a percentage change from the previous period.
4. Common-Size Statement: A financial statement with each line item expressed as a percentage of a base value.
5. Base Value: The value used to express each line item as a percentage, usually net sales or total assets.
6. Percentage Change: The percentage change in a line item from the previous period.
7. Vertical Analysis Ratio: A ratio that expresses each line item as a percentage of a base value.
8. Horizontal Analysis Ratio: A ratio that compares line items over time, usually as a percentage change from the previous period.
9. Adjust for inflation or other external factors to ensure accurate comparisons.
10. Industry-specific trends: Research industry-specific trends and benchmarks to ensure accurate comparisons.