Financial statement analysis is done by every successful corporation, as your team at Ventura Electronics very well knows. “Comparisons within a company are often useful to detect changes in financial relationships and significant trends” (Kimmel, Weygandt, and Keiso p. 653). Financial statement analysis is done by horizontal analysis, vertical analysis, and ratio analysis. “Horizontal analysis, also known as trend analysis, is a technique for evaluating a series of financial statement data over a period of time (Kimmel, Weygandt, and Keiso p. 54). If Ventura Electronics is interested in determining any increase or decrease in, for example, net sales (as an amount or percentage) than horizontal analysis are appropriate. Vertical analysis analyzes more specific data on the financial statement. “Vertical analysis, also called common-size analysis, is a technique for evaluating financial statement data that expresses each item in a financial statement as a percent of a base amount”(Kimmel, Weygandt, and Keiso p. 656).
Ventura Electronics can not only analyze the relative size of each category on the financial statement, but can also see the percentage change in the individual asset, liability, and stockholders’ equity. Ventura Electronic can also use this analysis when comparing its financial statements to the competition. The last tool commonly used for financial statement analysis is ratio analysis. These ratios are useful in evaluating the financial health and performance of a company.
In ratio analysis we use three different ratios; liquidity ratios, solvency ratios, and profitability ratios. Liquidity ratios are important because it evaluates the short-term ability of a business to pay their obligations as well as meet their unexpected cash flow needs. When Ventura Electronics wants to measure the ability of the company to survive over a long period of time then solvency ratios are appropriate. Profitability ratios evaluate the income of the business or their operating success over a given period of time.
Ventura Electronics would find this ratio very important in analyzing the company’s income and to evaluate the ability for the business to obtain debt and equity financing, its liquidity position, and its ability to grow. As CEO, this ratio would be useful when determining the managements operating effectiveness. It is very important for Ventura Electronics to provide “full and transparent information that will not confuse or mislead users of the financial statements” (Kimmel, Weygandt, and Keiso p. 61) this is called quality of earnings. When Ventura Electronics performs a financial statement analysis to evaluate the financial performance of the company using the methods above, it is important to maintain a high quality of earnings. Factors that affect quality of earnings are; alternative accounting methods, pro forma income, improper recognition, and price-earnings ratio.
Though financial statement analysis is important for Ventura Electronics, it also has its limitations The limitation of financial statement analysis occurs with ratio analysis. Though this analysis is very useful to the company in analyzing internal factors, Ventura Electronics cannot compare ratios to their competitors accurately. Differences in accounting methods limit ratio analysis in comparing companies. As the CEO you understand the importance of knowing where the company stands as compared to its competitors. Ratio analysis also limits Ventura Electronics to analyze the definite future of the organization.
They do not account for industry trends, technological changes, changes in consumer tastes, changes in broad economic factors, and changes within the firm itself. Though ratio analysis has its limitations; horizontal and vertical analysis makes up for these limitations. So as you can see, if the methods for financial statement analysis listed above are used, Ventura Electronics can receive a great knowledge and insight into how successful the company is and could be and make proper decisions based off these evaluations.
Courtney from Study Moose
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