Academic journal article
By Hughes, Jesse; Katwal, Meena
The Journal of Government Financial Management , Vol. 61, No. 3
Information in financial statements published in the private sector is very closely tracked as investors make the decision to buy or sell stocks in the company. Earnings are one of the many factors that may impact the price of the stock. So, financial statements act as a guide for an investor as they can refer to them frequently. Financial statements in the public sector are also very important but are frequently not used in the decision making process. Since the public sector is more thinly capitalized than the private sector, the ability to pay its debt in a timely manner and to achieve fiscal sustainability is very important. In this article, we discuss different types of analysis used in the public sector and how globalization may demand changes in the accounting practices in the public sector for harmonization throughout the world.
Types of Analysis
Horizontal (year to year) - Horizontal analysis is the process of comparing particular items in a financial statement over a period of time. For instance, from the income statement expenses of several years can be compared with each other to see how they are changing; from the balance sheet, the Accounts Receivable may be compared across several months in the same accounting period. These comparisons can be done either in absolute dollar terms or in percentages.
i) Percentage- -This method is particularly useful when comparing companies of different sizes. The dollar value of the change in the financial item of Interest is converted into a percentage form. For instance, a change in the accounts receivable from $100 to $150 is a 5% increase. Thus the percentage increase or decrease in Accounts Receivable may be compared over a number of years.
ii) Absolute Dollars - This method compares the dollar amounts of specific items over a period of time. For example, absolute dollar amount of Accounts Payable may be compared over several months or years. By tracking the Accounts Payable amounts over a number of period we can have an idea of how much we are buying on credit and whether we are paying in time to take advantage of the early payment discounts, when the amounts come due and if we have enough liquid assets in hand to settle the payments when they come due without incurring any penalties for paying late. By comparing the payables across several periods we can analyze how efficiently we are handling our payables.
Vertical (financial element to financial element) - A vertical analysis can be performed of either the income statement item or of the balance sheet item. In a vertical analysis. different figures in a financial statement are compared to a specific figure in the same accounting period. It is reported as a percentage.
i) Balance Sheet - Each figure in the balance sheet is compared to total assets or each figure is compared to total equity. So, each item can be represented as a percent of total equity or total assets. For instance, if total cash in the period is 1000 and total equity is 10000, the total cash as a percentage of total equity would be 10%. Therefore, each item in the balance sheet can be represented as a percentage of total assets or total equity.
ii) Income Statement - Vertical analysis of the income statement is done by comparing each item in the income statement with the total sales in the period. For example, if Net Income is $100 and Sales is $1000 then the Net Income as a percentage of Sales would be 10%. Thus, each item in the income statement could be represented as a percentage of Sales.
Trend (over a number of years) - The comparison of the components or ratios derived from the financial statements over a number of years is called trend analysis. Trend analysis is based on the theory that what has happened in the past is a good indicator of what might happen in the future. With the analysis of the magnitude and direction of the trend, we might be able to predict what we can expect to see in the immediate future and plan accordingly. …