This lesson covers the three fundamental analytical techniques used to evaluate financial statements, as required by the US CMA syllabus and European university curricula .

• Horizontal Analysis (Trend Analysis): Horizontal analysis involves comparing financial data across multiple periods to identify trends and growth patterns. It calculates the percentage change in each line item from a base year or period. This technique helps answer questions such as: “Is revenue growing?”, “Are expenses increasing faster than revenue?”, and “Are there significant changes in asset or liability composition over time?” .

• Vertical Analysis (Common-Size Analysis): Vertical analysis expresses each line item of a financial statement as a percentage of a single base item in the same period. This standardises the data, allowing for meaningful comparisons between companies of different sizes and for a single company over time .

  • Vertical Common-Size Balance Sheet: Each balance sheet item is divided by total assets, showing the composition of the company’s resources and financing sources.

  • Vertical Common-Size Income Statement: Each income statement item is divided by revenue, showing the relative proportion of each expense and the profit margins.

• Ratio Analysis Categories: Financial ratios are used to evaluate different aspects of performance :

  • Liquidity Ratios: Measure the company’s ability to meet short-term obligations (current ratio, quick ratio).

  • Activity Ratios: Measure the efficiency of operations and asset utilization (inventory turnover, receivables turnover).

  • Solvency/Leverage Ratios: Measure the company’s ability to meet long-term obligations (debt-to-equity, interest coverage).

  • Profitability Ratios: Measure the company’s ability to generate profits (gross margin, return on equity).

• Limitations of Ratio Analysis: Analysts must be aware of the limitations of ratio analysis, including differences in accounting policies, the use of historical data, and the potential for manipulation. Ratios should be used in conjunction with other analytical techniques .