The percentage analysis of the relationship of each component in a financial statement to a total within the statement is called vertical analysis. In a vertical analysis of the balance sheet, the percentages are computed as follows: o o
Each asset item is stated as a percent of the total assets. Each liability and stockholders’ equity item is stated as a percent of the total liabilities and stockholders’ equity.
In a vertical analysis of the income statement, each
In a common-sized statement, all items are expressed as percentages, with no dollar amounts shown. Common-sized statements are useful for comparing one company with another or comparing a company with industry averages.
A company’s ability to pay its current liabilities is called current position analysis. Current position analysis is a solvency measure of special interest to short-term creditors and includes the computation and analysis of the following: o o o
Common profitability analyses include the following: o o o o o o o
Ratio of sales to assets Rate earned on total assets Rate earned on stockholders’ equity Rate earned on common stockholders’ equity Earnings per share on common stock Price-earnings ratio Dividends per share Dividend yield
Management Discussion and Analysis • Management’s Discussion and Analysis (MD&A) is required in annual
reports filed with the Securities and Exchange Commission. It includes management’s analysis of current operations and its plans for the future. Typical items included in the MD&A are: o o
o o o
Management’s analysis and explanations of any significant changes between the current and prior years’ financial statements. Important accounting principles or policies that could affect interpretation of the financial statements, including the effect of changes in accounting principles or the adoption of new accounting principles. Management’s assessment of the company’s liquidity and the availability of capital to the company. Significant risk exposures that might affect the company. Any “off-balance-sheet” arrangements such as leases not included directly in the financial statements.
The Sarbanes-Oxley Act of 2002 requires a report by management. o o
The report states management’s responsibility for establishing and maintaining internal control. In addition, management’s assessment of the effectiveness of internal controls over financial reporting is included in the report.
Sarbanes-Oxley also requires a public accounting firm to verify management’s conclusions on internal control. o
All publicly held corporations are required to have an independent audit (examination) of their financial statements. The Certified Public Accounting (CPA) firm that conducts the audit renders an opinion, called the Report of Independent Registered Public Accounting Firm, on the fairness of the statements.