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Proper presentation of the financial statement is very important in any business. The statements are used by external and internal parties including managers, creditors and executives. The users rely on the information in the financial statements to make critical decisions. Therefore, the information must be analyzed and presented properly to enhance the understanding to the users.

Financial statement is usually analyzed using two major methods namely vertical and the horizontal statements. The two methods present the financial statement with different ways of analyzing the financial statement’s component. A vertical analysis presents the items of the financial statement and their relationships as a percentage. The assets in the balance sheet are presented as a percentage of the total assets. In addition, each liability or even the items in equity are presented as the percentage of the summation of the liabilities and equity. In vertical analysis, the statement of profit and loss presents the items as the percentage of net sales. Therefore, vertical presentation of analyzing financial statements makes use of common size statement. The common size items are very important in comparing the financial statements of different companies. The users are able to explore the vertical analysis of several time periods and be able to make meaningful decisions. The income statement in a vertical analysis compares every component as a percentage of sales while the balance sheet components are compared as percentage total assets (Palepu & Healy, 2008).

Horizontal Analysis

From the general view, both methods involve comparison of information. A horizontal analysis relates certain items or components over a number of financial periods. For instance, the value of account receivable can be compared over certain months within the accounting periods or even the expenses can be compared to another years. The horizontal analysis is done in two ways. The first method is the absolute dollars method. In this method, the absolute dollar amount of expenses is compared over several financial years. The method is very essential in determining if the business is conservative or excessive in using some items and also help in determining the influence outside factors on the business (Palepu & Healy,2008). The other method is the percentage method. In this method, the percentage variation items are compared over time. The change in dollar amount is changed into percentage rate. The method is only important in comparing small businesses to well established ones.

Ratio Analysis vs.Liquidity Ratio

The above ratios are used to analyze the capability of the company or business to meet its short terms debts   or obligations. The liquidity of business is measured using the following ratios:

Current Ratio

This is the basic liquidity test that shows the ability of the business to meet short term obligations using its short-term assets. Current ratio is supposed to be maintained at one or greater than one to signify that the business is able to meet short term obligation.

Current ratio= (current asset)/current liabilities.

Quick Ratio

It is almost the same as the current ratio only that it eliminates inventory and prepaid expenses from the values of the current asset because it’s more difficult to convert them into cash. It should also be maintained at one or more than one to ensure the business has no problem with liquidity.

Quick ratio=(cash+ account receivable +marketable securities)/ current liabilities

Cash Ratio

This ratio only measures the ability of the firm to use the cash to meet the short term obligations. The higher values of cash ratio the better the firm is in its ability to meet its short term obligation. Cash ratio= (cash+ marketable securities)/current liabilities.

The Solvency Ratio

These ratios are almost the same as liquidity ratio, only that solvency measures the ability of the firm to meet all obligations. Some of the ratios that are considered solvency ones, are current liabilities to net worth ratio, current liabilities to inventory, total liabilities to net worth ratio, fixed asset to net worth ratio and current ratio.

Profitability Ratios

These ratios enable the user to determine if the business is getting better or worse, if it is making any profit, and even compares it with that of the competitors. Some of the profitability ratios include gross margin given by gross profit over sales. High values show that the company is charging enough premiums for its goods. Another ratio is the return on equity (ROE). This one measures the company’s return on investment by shareholders. It is given by net income divided by the average shareholders’ equity (Palepu & Healy, 2008).

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