Learn about the various types of financial analysis.
There are various types of financial analysis:
- Vertical analysis
- Horizontal analysis
- Leverage analysis
- Ratio analysis (which includes liquidity analysis, profitability analysis, etc)
- Sensitivity analysis
- What-if analysis.
Each analysis has its own place and importance in financial analysis; however, the ones we will focus on are vertical analysis (most commonly used), horizontal analysis, ratio analysis and sensitivity analysis.
Before we dive into each of these, we need to review the different components of a financial statement in order to assist us with a financial statement analysis.
It is important to note that the following analysis focuses on financial statements; however, financial analysis has a broader focus and internally there are various different financial metrics that organisations, depending on their focus and departments, may have on hand.
After watching the video in the previous step, you should now have a basic understanding of the components of a financial report by an organisation. Let’s look at how we might perform a horizontal analysis.
- Horizontal analysis is one of the most commonly performed financial analysis techniques, and it allows us to evaluate trends across two chosen periods (e.g. year-on-year, quarter-over-quarter, etc.).
- The purpose of this is to be able to understand the past and use it as insight into what the company might do in the future.
- It is important to note that you should only compare like for like line items, for example, cost of sales 2020 vs cost of sales 2019.
See below an example from the Woolworths Annual Report 2019:
The formula for the horizontal analysis is:
- % Change = ((Amount in Comparison Year − Amount in Base Year) / (Amount in Base Year)) x 100
- If you don’t want a percentage, you simply omit the final step (multiply by 100)
(Source: Woolworths Annual Report 2019, pg 68) [1]
Vertical Analysis
Another common type of financial analysis is vertical analysis. Rather than looking horizontally across the financial statement, you analyse it vertically.
You would most commonly use vertical analysis on an income statement and would use it to show expense line items as a percentage of sales. Thus, you would look at each line item on the income statement and divide it by gross sales to see the percentage of each item as gross sales. You could do the same exercise on the balance sheet, except it would show as a percentage of total assets or similarly as total liabilities.
Unlike horizontal analysis, vertical analysis does not compare the two periods directly (eg, Y1–Y2), instead, it breaks down each period separately, allowing you to compare changes in percentages and try to determine why they may have changed. It allows you to see the correlation between single items and the bottom line. It is also extremely effective when comparing companies that might be of different sizes but in the same industry, as it lets you analyse operational differences at the same base.
(Source: Woolworths Annual Report 2019, pg 68) [1]
References
1. Woolworths Group Limited. 2019 Annual Report [Internet]. Available from: https://www.woolworthsgroup.com.au/icms_docs/195582_annual-report-2019.pdf
FAQs
Different types of financial analysis include valuation, variance, horizontal analysis, vertical analysis, liquidity, profitability, cash flow analysis, and more, which serve various purposes for analyzing a company's overall financial health.
What are the three types of financial analysis? ›
Several techniques are commonly used as part of financial statement analysis. Three of the most important techniques are horizontal analysis, vertical analysis, and ratio analysis.
What are the 5 techniques of financial analysis? ›
What are the five methods of financial statement analysis? There are five commonplace approaches to financial statement analysis: horizontal analysis, vertical analysis, ratio analysis, trend analysis and cost-volume profit analysis. Each technique allows the building of a more detailed and nuanced financial profile.
What are the 5 financial ratio analysis? ›
5 Essential Financial Ratios for Every Business. The common financial ratios every business should track are 1) liquidity ratios 2) leverage ratios 3)efficiency ratio 4) profitability ratios and 5) market value ratios.
What are the three financial statement analysis? ›
The income statement, balance sheet, and statement of cash flows are required financial statements. These three statements are informative tools that traders can use to analyze a company's financial strength and provide a quick picture of a company's financial health and underlying value.
What are the three pillars of financial analysis? ›
Three Pillars of Financial Management – what they are. Pillar #1 – Profit and Loss Statement. Pillar #2 – Balance Sheet. Pillar #3 – Cash Flow Projection.
What are the four tools of financial analysis? ›
Some of the most used financial tools based on their usage and requirements are common size statements (vertical analysis), comparative financial statements (comparison of financial statements), ratio analysis (quantitative analysis), cash flow analysis, and trend analysis.
How many types of analysis are there in finance? ›
Different types of financial analysis include valuation, variance, horizontal analysis, vertical analysis, liquidity, profitability, cash flow analysis, and more, which serve various purposes for analyzing a company's overall financial health.
What are the types of financial fundamental analysis? ›
Quantitative and qualitative fundamental analysis are the two main types of fundamental analysis techniques that investors use to evaluate stocks.
What are the 7 types of ratio analysis? ›
Financial ratio analysis is often broken into six different types: profitability, solvency, liquidity, turnover, coverage, and market prospects ratios.
- Working Capital Ratio.
- Quick Ratio.
- Earnings Per Share (EPS)
- Price-Earnings Ratio (P/E)
- Debt-to-Equity Ratio.
- Return on Equity (ROE)
One example of a financial analysis would be if a financial analyst calculated your company's profitability ratios, which assess your company's ability to make money, and leverage ratios, which measure your company's ability to pay off its debts.
How to analyze financial data? ›
There are generally six steps to developing an effective analysis of financial statements.
- Identify the industry economic characteristics. ...
- Identify company strategies. ...
- Assess the quality of the firm's financial statements. ...
- Analyze current profitability and risk. ...
- Prepare forecasted financial statements. ...
- Value the firm.
The balance sheet, income statement, and cash flow statement each offer unique details with information that is all interconnected. Together the three statements give a comprehensive portrayal of the company's operating activities.
What are the various techniques of financial statement analysis? ›
Methods of financial statement analysis
There are six widely used methods for analyzing financial statements: horizontal and vertical analysis, cost-volume-profit analysis, ratio analysis, trend analysis, and common-size analysis.
What are the 3 main types of financial statements and how do they differ? ›
The three main types of financial statements are the balance sheet, the income statement, and the cash flow statement. These three statements together show the assets and liabilities of a business, its revenues, and costs, as well as its cash flows from operating, investing, and financing activities.
What are the three 3 elements of financial management? ›
Most financial management plans will break them down into four elements commonly recognised in financial management. These four elements are planning, controlling, organising & directing, and decision making. With a structure and plan that follows this, a business may find that it isn't as overwhelming as it seems.
What is the 3 way financial model? ›
A three-way forecast, also known as the 3 financial statements is a financial model combining three key reports into one consolidated forecast. It links your Profit & Loss (income statement), balance sheet and cashflow projections together so you can forecast your future cash position and financial health.
(Source: Woolworths Annual Report 2019, pg 68) [1]
