Question

Describe the purpose of vertical analysis and how it is applied. Describe how internal and external users would approach financial analysis differently. What would their goals be?

Answer 1

A) Vertical analysis is a financial analysis tool that lists each line item on the financial statements as a percentage of its total category. In other words, it’s a method used to analyze financial statements by comparing individual entries as a proportion of their total accounts like assets, liabilities, and equity.

How Vertical Analysis Applied

For each account on the income statement, we divide the given number by the company's sales for that year. By doing this, we'll build a new income statement that shows each account as a percentage of the sales for that year. As an example, we'll divide the company's "Salaries" expense by its sales for that year. That result will appear on the vertical analysis table beside Salaries for year one.

B) Financial analysis involves using financial data to assess a company’s performance and make recommendations about how it can improve going forward. Vertical analysis is one of type of financial analysis.

Goal of Financial Analysis

There are 4 goal of financial analysis.

1. Solevncy:- One of the most important goals of financial analysis is to assess the ability of a business to pay back its debts (Short term and Long term) to its creditors. The liquidity of a business entity is reflected in its balance sheet.

2. Profitability:- It refers to a firm’s ability to earn income and sustain its growth in both long-term and short-term

3. Liquidity :- a financial analysis reports about the firm’s ability to sustain positive cash flow in addition to satisfying current debts. Just like the solvency of a firm.

4. Stability :- Stability implies the ability of a business firm to maintain its existence in the long run.