Financial Statement Analysis: Traditional And Contemporary Methods

Traditional Financial Statement Analysis

This report has been described about the critically analyse of the financial and operating position of corporations which is shepherding by the different traditional and contemporary methods. Financial statement is apprehended four vital business actions:  Forecasting, Capitalising, funding and operation. To make Effective economic decisions, financial statement analysis is the effective process by reviewing and analysing financial statements. Financial statement consists of the statement of financial performance, statement of financial position, statement of cash flows, and statement of changes in equity. Financial statement analysis has described a technique or way which involved identifying the risks, evaluating the performance, financial condition, and forthcoming predictions of the corporation. Actually, this analysis has been used by the multiplicity of interested party, as per investors of all categories, the supervision authority, and mainly the management of the company.  Usually, to analyse the financial statements, most popular two types of method has been used. One is called Traditional Methods and another is called Contemporary methods. The Most common process for financial statements analysis is been the practise the numerous of ratios. Mainly, the Ratios are using to compute the comparative dimensions of the individual amount in kin to a different. Principally, Ratios are easily compared to the same ratio which is calculated for the prior period, otherwise established of the average for the industry. It helps to measure that company is carrying out their activities according the expectations or not. The ratios change of the figure can take the attention of the commentator.  Other method is to calculation is horizontal and vertical analysis. Horizontal analysis is judge by the financial information which is presented sequence of reporting periods.  Vertical analysis has been done of the financial statement analysis followed by the comparative. It describes like every item of the financial statement is listed as a percentage of another item. In the contemporary methods, CAPM is very popular for analysis the risk effectively. DGM shows that how to grow the company dividends. It grows the perpetuity basis or different rates. And the last but not the list is EMH which idea is partly established by the Eugene Fama in the 1960s.

Financial analysis could be done through traditional as well as contemporary methods. Following study explains about the traditional method of the company and its critical evaluation:  

Horizontal analysis or trend analysis is a financial tool which is used to evaluate a financial statement data in excess of certain period of time. The purpose of the calculation is to evaluate the increase or the decrease and mainly used in intra company comparison.  The changes of the amount are easily identified and it is the most advantage in this financial tools. . But, sometimes difficulties create to do the calculations. As an example, there is no value an asset item has in the previous year but value is created in the next year, so the problem is percentage don’t calculated. On the other hand, the negative figures give the impression in the previous years and a positive figure exists the following year, but the percentage change cannot figure. The following is the formula of horizontal analysis:

Contemporary Financial Statement Analysis

According to the Charles, horizontal analysis is one of the best financial evaluation method because it makes it easy for the company to evaluate the financial data of the company and evaluate it with the past year data of the company. Further, Barry has added into his study that performance of the company could be easily evaluated through the horizontal analysis. In addition, Charles has added that horizontal analysis is one of the most used tools when the change into the financial performance of an organization is to be done. Further, Joshua has described that horizontal analysis assist the company to make strategic financial planning.

In addition, shortcomings of the horizontal analysis have been studied. Husayn has described that horizontal analysis could not be used to evaluate and compare the performance of the company with competitive company. Further, it has been explained by David that it is tough to choose the base year for the horizontal analysis study. More, it has been said that the various assumptions are required to be made for this study.

The study of horizontal analysis has been done on Tate and Lyle & Wolseley and it has been found that the financial performance of Tate and Lyle plc has been worst in 2016 in comparison of last 5 years. Currently, the gross profit of the company has been lowered by 5.25% and the net profit of the company has been lowered by 47.25%. Company is required to focus on this point.

On the other hand, the study of horizontal analysis has been done on Wolseley and it has been found that the financial performance of Wolseley plc has been better in 2016 in comparison of last 5 years. Currently, the gross profit of the company has been enhanced by 10.33% and the net profit of the company has been enhanced by 1056.14%. Company is required to manage the same level.

Vertical analysis is a financial tool which is used to evaluate a financial statement data in excess of certain period of time. The purpose of the calculation is to evaluate the competition level of the company in the industry and the changes into the financial performance of the company from last year.  The changes of the amount are easily identified and it is the most advantage in this financial tools. . But, sometimes difficulties create to do the calculations. As an example, there is an expense which has not been occurred in a company but has taken place into other company, so the problem occurs while evaluating the data. The following is the formula of vertical analysis:

Ratio Analysis

According to the Mario, vertical analysis is one of the most used financial evaluation method by professionals because it makes it easy for the company to evaluate the financial data of the company and evaluate it with the competitive company’s data of the company. Further, Tobias has added into his study that performance of the company and its financial performance in the industry could be easily evaluated through the vertical analysis. In addition, vertical analysis is one of the most used tools when the change into the financial performance of an organization is to be done in context with the competitive companies. Further, it has described that vertical analysis assist the company to make strategic financial planning.

In addition, shortcomings of the vertical analysis have been studied. It has described that vertical analysis could not be used to evaluate and compare the performance of the company with past year data. Further, it has been explained that it is tough to choose the competition company as the operations are quite different of each company. More, it has been said that the various assumptions are required to be made for this study.

The study of vertical analysis has been done on Tate and Lyle & Wolseley and it has been found that the financial performance, income and expenses have not been managed by the company in a better way. The gross profit and net profit of the company has been lesser in comparison with last year’s data. Further, the balance sheet of the company explains about the negative changes into the current assets, total debts etc of the company.  

On the other hand, the study of vertical analysis has been done on Wolseley and it has been found that the financial performance, income and expenses have been managed by the company in a better way. The gross profit and net profit of the company has been better in last year’s data. Further, the balance sheet of the company explains about the positive changes into the total assets, liabilities and equity of the company. 

Traditional ratio analysis is a financial tool which is used to evaluate a financial statement data in terms of other financial figures of the company. The purpose of the calculation is to evaluate the competition, liquidity, stability, profitability etc level of the company in the industry and the changes into the financial performance of the company from last year.  The changes of the amount could be easily identified through this tool. But, sometimes difficulties create to do the calculations. The following is the formula of few parts of traditional ratio analysis: 

Horizontal Analysis

Figure 3: Traditional ratio analysis formula

 Traditional ratio analysis is one of the most used financial evaluation method by professionals because it makes it easy for the company to evaluate the financial data of the company and evaluate it with the competitive company’s data of the company and the past year performance of the company. Further, it has added into his study that performance of the company and its financial performance in the industry could be easily evaluated through the ratio analysis. In addition, it has added that traditional ratio analysis is one of the most used tools when the change into the financial performance of an organization is to be done in context with the competitive companies and with the historical data of the company. Further, it has described that traditional ratio analysis assist the company to make strategic financial planning.

In addition, shortcomings of the ratio analysis have been studied. It has described that ratio analysis study is based on various assumptions. Further, it has been explained that it is tough to compare the data with the competitive companies. Further, the different level of ratios is set by the company according to its nature and policies.  

The study of traditional ratio analysis has been done on Tate and Lyle and it has been found that the profitability level, liquidity level, solvency level and efficiency level have been managed by the company in a better way. The profitability level of the company is impressive on the other hand, liquidity position explains to reduce the level of current assets. Further, the efficiency and solvency of the company explains about the good position of the company.  

On the other hand, the study of traditional ratio analysis has been done on Wolseley and it has been found that the profitability level, liquidity level, solvency level and efficiency level have been managed by the company in a better way. The profitability level of the company is quite impressive. On the other hand, liquidity position explains to reduce the level of current assets. Further, the efficiency and solvency of the company explains about the few changes into the policies and capital structure of the company.

The above study of traditional method of financial evaluation technique expresses that all the techniques have some pros as well as some cons. An organization should choose the financial evaluation technique according to its nature, needs and objectives. 

Vertical Analysis

Financial analysis could be done through traditional as well as contemporary methods. Following study explains about the contemporary method of the company and its critical evaluation:  

Capital asset pricing model is a financial tool which is used to evaluate the valuation of the company on the basis of the stock price and the changes into the stock price in comparison with the stock price of the stock exchange in which the company has registered its stock. The purpose of the calculation is to evaluate the cost of equity so that it becomes easy for the company to make a decision about capital rising.  The changes of the amount and the cost could be easily identified through this tool. But, sometimes difficulties create to do the calculations due to the risk free rate and market return premium. The following is the formula of CAPM analysis:

It has described into his study that capital asset pricing model is way better than traditional financial evaluation methods due to its huge area as it takes the concern of internal as well as market changes of the company. It has been added further that for calculating the CAPM, risk free rate, market premium, and beta is required to evaluate which could be found through the market. This makes it easy for the company to evaluate the total cost and the performance of the company. Further, it has been evaluated that the CAPM does not based on the assumptions. Always real values are taken to evaluate the performance and the required rate of return of the company. Further, on the basis of required rate of return, it becomes easy for the investors to make a decision about the investment or divestment from the stock of the company. Thus it could be said that this option is way better than traditional methods of financial analysis.

Dividend growth model is a financial tool which is used to evaluate the valuation of the stock price of the company and the changes into the stock price (face value and market value). This model could be conducted through the help of dividend payment, dividend growth rate and the cost of equity. The purpose of the calculation is to evaluate the value of the shares so that it becomes easy for the investors to make a decision about investment in the company.  The changes of the amount and the value of shares could be easily identified through this tool. But, sometimes difficulties create to do the calculations due to the growth %. The following is the formula of dividend growth model analysis: 

CAPM (Capital Asset Pricing Model)

 It has described into his study that dividend growth model is way better than traditional financial evaluation methods due to its huge area as it takes the concern of internal as well as market changes of the company. It has been added further that for calculating the DGM, dividend payment, growth rate, and cost of equity is required to evaluate which could be found through the market. This makes it easy for the investors to evaluate the worth of the stock of the company. Further, it has been evaluated that the DGM is based on the assumptions. The growth rate of the company is always assumed. Further, on the basis of dividend growth model, it becomes easy for the investors to make a decision about the investment or divestment from the stock of the company. Thus it could be said that this option is way better than traditional methods of financial analysis.

 Effective market hypothesis is also a contemporary method to evaluate the financial performance of a company. This theory explains about the stock market tactics. It explains that the stock of an organization is always traded by the stock exchange on a fair price. If the stick price gets higher or lower than a level, then the trade of this stock is banned by the stock exchange. This theory is most conflicted theory. Many financial analysts argue that the stock price and the value depend on the trading of the stocks and the internal changes of the stock. Traders can not affect the stock price of an organization. Though, various assumptions are required by this theory to prove.

Conclusion:

The above study of traditional method and contemporize methods of financial evaluation technique expresses that all the techniques have some pros as well as some cons. An organization should choose the financial evaluation technique according to its nature, needs and objectives. The study of horizontal analysis is a financial tool which is used to evaluate a financial statement data in excess of certain period of time to compare the financial performance of an organization with past year data of the company. Further, the study of vertical analysis is a financial tool which is used to evaluate a financial statement data in excess of certain period of time to compare the financial perf9ormance of an organization with its competitive companies. In addition, the study of traditional ratio analysis is a financial tool which is used to evaluate a financial statement data in excess of certain period of time to compare the financial performance of an organization with past year data of the company as well as the competitive company.

DGM (Dividend Growth Model)

At the same time, the contemporary methods evaluate that the CAPM model assist the company to make a better decision while raising the funds for further investment of the company. DGM model is used by the investors to evaluate the next year dividend of the company or the stock price of the company. At the same time, EMH explains that the stock of an organization is always traded by the stock exchange on a fair price. If the stick price gets higher or lower than a level, then the trade of this stock is banned by the stock exchange.

Thus through the above study and the literature review, it has been evaluated that the method of traditional ratio is way better than other methods of the company. This technique is way better due to its huge area and different results. 

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