Differentiate between the balance sheet and income statement.
Financial statements are representations of a company's performance in terms of the position of its finances and cash flows. The balance sheet and income statements are examples of such representations. The balance sheet represents a company's financial situation within a particular period of the actual reporting time, showing assets, liabilities and equity. The income statement on the other side is a representation of the company’s financial position for the whole period of reporting. It represents all financial aspects of a business such as sales, purchases, less expense. It computes the net profit or loss and may also include share earnings (Bragg, 2015).
Differentiate between Horizontal and vertical analyses of financial statements.
There are two studies in which users can scrutinize the financial statements: the horizontal and vertical analyses. Horizontal analyses refer to the analyses of financial reports based on different financial periods by concentrating on the drift and change in items of financial statements of a company aiding in the detection of growth sequence. A vertical analysis bases its analyses on the relative size of specific elements of the financial statement and any significant changes that may have happened over time hence determination of the composition of each financial statement (Putra, 2009).
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How can one use financial ratios to make investment decisions?
Financial ratios are representations of business assets against its liabilities that reflect the position of the business in terms of debts, ability to pay the debts and make a profit. By showing the relation of assets to liabilities, a value investor can derive the financial position of a business and its potential to be profitable hence decide whether or not to invest in the business. Value investing relies on the company's performance and financial position which are all derived from evaluating the financial ratios over some simultaneous financial periods (Internet Centre for Management and Business Administration, 2010).
Why is necessary to use either a horizontal or vertical analysis when working with a financial statement.
Both the horizontal and vertical analyses represent the growth of the company’s revenue and trends of the revenue and profit respectively. By determining the growth rates and how this rate fluctuates in relation to the income, one is in a better position to define the company's position and compare different company's so as to make the best decision. Each analysis will equip the financial statement user with precise information as a percentage of revenue to determine each company’s position and its financial statement composition (Szramiak, 2017).
Do you think both horizontal and vertical analyses are necessary or businesses can opt to do one analysis and still have the whole financial picture of the business?
Both reviews play a significantly different role in representing the image of business in terms of the financial position by factoring in various aspects of the firm's finances. The horizontal analysis shows the changes over time of the specifics of financial statements while the vertical analysis lists the trends in the constituents of the financial statements. All these aspects are vital in determining the financial position of each company; therefore, it is more efficient to use both analyses (Szramiak, 2017).
If you were going to buy a business and have only one option regarding the analyses of horizontal and vertical, which analysis would you use and why?
The vertical analysis shows the changes in the particulars of the financial statements. This means it outlines the trends in sales, purchases, expenses, revenue, assets, and liabilities as single components of the financial statements. This, in turn, means the vertical analysis is more detailed and breaks down the financial statement to represents very specific financial details pinpointing the variation in each. Hence, this makes a vertical analysis of the income statement the preferable choice of analyzing financial statements.
What do you think is the main difference between a balance sheet and an income statement? As part of your answer, provide a numerical example and explain it.
The main difference between a balance sheet and an income statement is the scope of elements and the financial period each covers when representing a company's financial position. Balance sheets include sections of the financial period while income statements cover an entire financial reporting period. Balance sheet represents assets, liabilities, and equity generally while income statements show current assets and liabilities and derive the net profit or loss (Bragg, 2015).
Numeric example a.
Income statement
For Best Dairies
For the year ended 31st December 2010
Net sales $3,800,000
Cost of goods sold $3,000,000
Gross profit $800,000
Less operating expenses $350,000
Net profit $450,000
Balance sheet
Best Dairies
For the year ended 31st December 2010
Non-current assets
Delivery trucks $10,000,000
Refrigeration machines $7,000,000
Current assets
Cash $200,000
Bank $15,000,000
Profit $450,000
Total assets $32,200,000
Noncurrent liabilities
Loan $1,000,000
Current liabilities
Payables $50,000
Total liabilities $1,050,000
Equity $31,150,000
Total equity and liabilities $32,200,000
Can you explain with a numerical example, the difference between the income statement and the balance sheet?
The income statement and the balance sheet are different in terms of the composition and the part of financial reporting section and period they represent. The income statement focuses on the operating part of the business within the financial period under review while the balance sheet represents the overall position of the company as at the period covered by the report. From the numeric example a. one can see that the income statement derives the net profit or loss while the balance sheet factors in all the aspects of the business in terms of its worth.
References
Bragg, S. (2015). Types of financial statements. Accounting tools.com . Retrieved on 1 June 2017 from https://www.accountingtools.com/articles/types-of-financial-statements.html.
Internet Centre for Management and Business Administration (2010). Financial ratios. NetMBA.com . Retrieved on 1 June 2017 from http://www.netmba.com/finance/financial/ratios/.
Putra, D. L. (2009). Horizontal vs. vertical analysis of financial statements. Accounting Financial & Tax . Retrieved on 1 June 2017 from http://accounting-financial-tax.com/2009/10/horizontal-vs-vertical-analysis-of-financial-statements/.
Szramiak, J. (2017). Two ways to analyze an income statement. Vintage value investing, Business Insider . Retrieved on 1 June 2017 from http://www.businessinsider.com/horizontal-and-vertical-analysis-of-income-statements-2017-3?IR=T.
