Methods of Analysis
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Financial analysis is the application of various accounting tools to assess the stability, profitability and viability of an organization or a project. Financial analysis applies methods such as vertical, horizontal and ratio analysis to evaluate financial statement and other reports. Secondly, users of financial information such as investors, employees and management use the information to make different decisions. For example, they evaluate future performances or competitiveness of the organization. As a result, extrapolation of a firm's past performance through the various accounting techniques allows stakeholders to make relevant decisions.
Horizontal analysis examines financial statements over an accounting period. Also known as trend analysis, it allows assessment of relative changes in different components over the time. Additionally, it indicates the behavior of expenses, revenues among other line items of financial statements. As a result, the items under consideration are similar. Secondly, the accounting period can be a month, a quarter or a year. However, it also depends on the analyst’s discretion (Epstein & Schneider, 2014). Finally, there can be used either absolute or percentage comparisons in horizontal analysis. The first method compares the amount of some item over the period and enables an anayst to identify the items that are changing significantly. For example, it can compare the cash in hand at the end of accounting periods. The second method converts the absolute figure into a percentage and determines relative changes (Penner, 2004).
Vertical or common-size analysis identifies the relationship between items in the same financial statement as a percentage of the total. As a result, it compares different items to a single item in the same financial period. Secondly, in this type of analysis there is used a common size statement from the income statement and balance sheet. For example, a common size balance sheet compares respective items to the total assets, liabilities and equity. The common-size profit and loss account uses sales to compare the various items in the statement. The limitations to the technique are that it can only evaluate items for one accounting period (Penner, 2004).
Financial ratios are a range of tools used to establish the performance of various items in financial statements in relation to others. Unlike the above two methods, the technique can use both items from the statement of financial performance and financial position. The general procedure involves identifying the ratios in relation to profitability, liquidity, efficiency, and leverage among others (Penner, 2004).
In the healthcare setting horizontal analysis assists stakeholders such as the hospital administrators to control inventory and cost. For example, the administrator evaluates the change in inventory and identifies items not commonly used. As a result, he reduces the purchases and allocates the funds in other areas. Secondly, with the use of common size statements administrators can identify items such as inpatient services revenue to total revenue. Finally, ratio analysis can be used to evaluate various inpatient and outpatient services by the patients’ mix. For example, patients’ mix can show the turnovers in services offered by the organization (Epstein & Schneider, 2014).
In conclusion, the user of financial information evaluates and extrapolates it with the help of horizontal, vertical and ratios analysis. Vertical analysis shows the relationship among the components of financial statements as a percentage to a single item such as sales or total assets. Horizontal analysis enables financial analysts to compare items in the statement for different periods. As a result, each item has an entry in the current period column and another period column. Ratio analysis, on the other hand, uses a mix of components in both statements of financial performance and positions relevant to the interest of the financial analyst.