Difference between Vertical and Horizontal Analysis - Assignment Example

Financial information is very useful for managers and external stakeholder groups such as lenders, suppliers, governmental entities, and investors.The most important financial reports that companies publish on a trimester or yearly basis are the financial statements. The four major financial statements are the income statement, balance sheet, statement of retained earnings, and the statement of cash flow (Weygandt, Kieso, Kimmel, 2002). All public companies are required by the Securities and Exchange Commission to include its financial statements within the content of the annual report.

The managerial staff of a company is the stakeholder group that uses financial statements the most in their decision making process. Performing research regarding financial information can be very useful. Historical financial information can be used to determine patterns concerning the performance of a business enterprise. An accountant or manager can use historical data such as the sales numbers of an enterprise to investigate patterns. For instance the sales figures of the company during the past five years can reflect a downward or upward tendency.

Based on that trend the manager can make decisions to change the strategies of the firm. Historical financial data can also be used to predict the future. Financial data can be inserted into statistical models such as regression analysis in order to obtain a forecast. Other research techniques such as the Delphi method can also be useful for forecasting purposes. Analysis of financial statements is essential for the decision making process of a company. Three techniques that managers can use to analyze financial statements are ratio analysis, vertical analysis, and horizontal analysis.

Ratio analysis can be subdivided into five categories. The five categories of ratio analysis are liquidity, financial leverage, asset efficiency, profitability, and market value ratios. Vertical analysis reports each amount on a financial statement as a percentage of another item, while horizontal analysis looks at the amounts of the financial statements over the past years (Accountingcoach, 2012). Financial statements are also useful for planning purposes. Inventory management can be enhanced by using the data within financial statements.

The use of data in the financial statements can help improve the planning process for the inventory account. Inventory is a current asset within the balance sheet of a company. The inventory turnover ratio can be calculated using financial statement data. It measures how many times a company’s inventory has been sold during a year (Garrison & Noreen, 2003). Managers must utilize financial information as a benchmark to make better decisions. If a manager is faced with a business decision regarding a project or an acquisition it is imperative that they analyze the financials of the business alternative in order to make informed decisions.

Techniques such as the net present value (NPV), payback period, and internal rate of return can be used to determine whether a business project should be accepted or rejected. The net present value technique takes into consideration the time value of money. This analytical technique incorporates the concept of present value. The present value concept deals with calculating how much future money is worth based on today’s dollar. The net present value method is a method of evaluating capital investment proposals by finding the present value of future net cash flows, discounted at the rate of return required by the firm (Beasley & Brigham, 2000).

Based on the net present value method a project is accepted only if its NPV is above cero. Projects with negative NPV should be rejected since they do not add any value. Another financial concept that can be used by managers to make certain decisions is the future value. The future value refers to the amount to which a cash flow or series of cash flows will grow over a given period of time when compounded at a given interest rate (Besley, et. al, 2000). Future value calculations can be useful to determine the value of a savings account in the future.

The financial statements of a company as well as other financial data are important information that can be used by managers to make better decisions. Managers that are not savvy in accounting or finance must rely on their accountants for advice to ensure due diligence. Disregarding financial information can lead to major mistakes. It is the responsibility of publicly traded companies to release financial statements to the public at least once a year. Investors rely heavily on the financial statement results to make decisions regarding their investment.

Managers should use financial information in their planning process and in their decision making regarding capital projects. References Accountingcoach.com (2012). What is the difference between vertical and horizontal analysis? Retrieved January 27, 2012 from http://blog.accountingcoach.com/vertical-analysis-horizontal-analysis/ Besley, S., Brigham, E. (2000). Essentials of Managerial Finance (12th ed.). Forth Worth: The Dryden Press. Garrison, R., Noreen, E. (2003). Managerial Accounting (10th ed.). Boston: McGraw-Hill Irwin.

Weygandt, J., Kieso, D., Kimmel, P. (2000). Accounting Principles (6th ed.). New York: John Wiley & Sons.