Horizontal and Vertical Analysis Financial Analysis Finance Lesson
LessonPlan
Plan
Performance Objective Students will understand the importance of horizontal and vertical analysis in predicting the future financial performance of a company. Specific Objectives  Calculate horizontal, or trend, analysis  Calculate vertical, or common size, analysis  Understand the implications of these types of analyses on analyzing business performance Terms  Horizontal analysis‐ also called trend analysis; the same numbers or ratios are compared over more than one time period  Vertical analysis‐ also called common‐size analysis; different account amounts are compared to a total on the same financial statement  Trend analysis‐ financial analysis that examines accounts over multiple time periods; used in horizontal analysis  Common‐size analysis‐ financial statements that show items as percentages of a common total; used in vertical analysis Time When taught as written, this lesson should take approximately three to four days to teach. Preparation
TEKS Correlations This lesson, as published, correlates to the following TEKS. Any changes/alterations to the activities may result in the elimination of any or all of the TEKS listed. 130.168 (c) Knowledge and Skills (2) The student describes tools, strategies, and systems used to maintain, monitor, control, and plan the use of financial resources. (3) The student demonstrates mathematics knowledge and skills required to pursue the full range of postsecondary education and career opportunities. The student is expected to: (a) demonstrate knowledge of arithmetic operation such as addition, subtraction, multiplication, and division; (b) demonstrate use of relational expressions such as equal to, not equal to, greater than, less than; Copyright © Texas Education Agency, 2014. All rights reserved.
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(c) apply data and measurements to solve a problem; and (e) construct charts, tables, and graphs from functions and data. (4) The student manages financial resources to ensure solvency. The student is expected to: (e) interpret financial statements; and (f) describe types of financial analysis such as ratio analysis and trend analysis. Interdisciplinary Correlations English‐English I  110.31(b)(1) Reading/Vocabulary Development. Students understand new vocabulary and use it when reading and writing.  110.3(b)(11) Reading/Comprehension of informational text/procedural texts. Students understand how to glean and use information in procedural texts and documents. Math‐Algebra I  111.32(b)(1)(C) Interpret and make decisions, predictions, and critical judgments from functional relationships. Occupational Correlation (O*Net – www.onetonline.org/): Job Title: Financial Analyst O*Net Number: 13‐2051.00 Reported Job Titles: Securities Analyst, Investment Analyst, Research Analyst Tasks  Interpret data on price, yield, stability, future investment‐risk trends, economic influences, and other factors affecting investment programs  Prepare plans of action for investment, using financial analyses  Present oral or written reports on general economic trends, individual corporations, and entire industries Soft Skills: Judgment and Decision Making, Mathematics, Critical Thinking Accommodations for Learning Differences It is important that lessons accommodate the needs of every learner. These lessons may be modified to accommodate your students with learning differences by referring to the files found on the Special Populations page of this website. Preparation  Review and familiarize yourself with the terminology and website links.  Have materials and websites ready prior to the start of the lesson. References  http://faculty.philau.edu/lermackh/financial_analysis.htm  Contemporary Mathematics for Business and Finance, South‐Western Publishing Copyright © Texas Education Agency, 2014. All rights reserved.
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 Century 21 Accounting; Advanced, South‐Western Publishing Instructional Aids  Textbook or Computer Program Diagrams/Charts  Lesson 1.01 Presentation  Instructor Computer/Projection Unit  Online Websites Introduction
The main purposes of this lesson are to help students understand  the importance of looking at past data to make predictions about the future  there is more than one way of analyzing data  a combination of analysis methods may be needed to get an accurate picture of a company’s performance Ask students if they know how to tell if a company is performing well. Ask students if they know that examining the past account balances of a company over time can help provide insight as to what might happen in the future. Copyright © Texas Education Agency, 2014. All rights reserved.
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Outline
I. II. III. IV. Two Types of Financial Analysis A. Horizontal B. Vertical What is Horizontal Analysis? A. also called Trend Analysis B. shows changes in amounts on financial statements over time C. compares the same accounts over time (“apples to apples”) D. uses a Comparative Balance Sheet (includes more than one accounting period on the same document) Calculations and Horizontal Analysis A. Changes can be shown in dollar amounts or percentages. B. Dollar amounts are simply calculated by subtracting the original period amount from the current period amount. C. Percentages are calculated by dividing the dollar amount of change by the amount in the original period, and then multiplying the answer by 100. When students hear the word “analysis,” they may feel a little apprehensive. Introduce them to the topic of analysis by looking at their GPA. List some of their subjects on the board, and at the top, write down at least three grading periods (for example, Spring 2011, Fall 2011, and Spring 2012.) Have students volunteer to write down grades for each class (A, B, C, D, or F). Calculate the GPA for each semester at the bottom of each grading period. When your chart is done, ask students how they can tell what their grades have done over time. Have they gone up, gone down, or stayed the same (for the same type of subjects). Explain that this is similar to Horizontal Analysis. Next, ask them to look at certain subjects in relation to their GPA. Obviously A’s will count for a larger percentage of their GPA than an F will. Explain the similarity of this analysis to that of vertical analysis. Horizontal Analysis Implications A. If management expected Net Income to increase by 20% (continued) Multiple Intelligences Guide
Existentialist
Interpersonal
Intrapersonal
Kinesthetic/
Bodily
Logical/
Mathematical
Musical/Rhythmic
Naturalist
Verbal/Linguistic
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Visual/Spatial
V. What is Vertical Analysis? A. Vertical analysis is also called common‐size analysis. B. Amounts are shown as a percentage instead of dollar amounts. C. The amounts are not necessarily compared over time to the same accounts, as in horizontal or trend analysis, but different amounts are compared to a common total on the same financial statement. …and it only increased 10%, management will need to look at whether Sales could have decreased or if Expenses could have increased. B. If Accounts Receivable decreased by 30 % from one year to the next, either the existing credit accounts are being paid off by the customers, or new customers could be paying in cash as opposed to credit. V. Wh VI. Calculations and Vertical Analysis A. Calculated by dividing the individual amount by a base amount, then multiplying by 100. B. On the Balance Sheet, Total Assets, Total Liabilities, or Total Stockholder’s Equity are typically used as the base amounts. Show the students the presentation slides with explanations of how to calculate using horizontal analysis. If you have a computer lab, direct students in pairs to any search engine that has a Finance part of the website. Look for financial statements for a company that you give them and make calculations on an interactive white board or on a document camera. You can also show them on a company website to look for Investor Relations. That should have financial statements or an Annual Report. Ask students if they remember how to calculate percentages, how their math teachers probably said part/whole. Show students how vertical analysis is done by comparing an account to a total. As an example, show them how to calculate Cash as a part of Total Assets. The answers in… at is Vertical Analysis? A. also called common‐size analysis B. own as a percentage C. amounts not necessarily compared ov as in horizontal or trend analysis, Multiple Intelligences Guide
Existentialist
Interpersonal
Intrapersonal
Kinesthetic/
Bodily
Logical/
Mathematical
Musical/Rhythmic
Naturalist
Verbal/Linguistic
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Visual/Spatial
C. On the Income Statement, Total Sales is typically the base amount. VII. Vertical Analysis Implications A. If Accounts Receivable represents a large percent of Total Assets (that percentage would have to be established by management), management may want to tighten its credit policies. B. If the Cost of Goods Sold is an especially high percent of Sales or Revenue, more sales will be necessary to cover the costs. vertical analysis will always be a percentage because you are comparing a “part” to a “whole.” There may be many ‘parts’ that a company will not want to be too large a percentage of the ‘whole’, possibly unless it is Cash. Ask students what accounts could signify something negative if it were too large a percent. Multiple Intelligences Guide
Existentialist
Interpersonal
Intrapersonal
Kinesthetic/
Bodily
Logical/
Mathematical
Musical/Rhythmic
Naturalist
Verbal/Linguistic
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Visual/Spatial
Application
Guided Practice On the Internet, the teacher can locate Comparative Balance Sheets and Income Statements with horizontal analysis and vertical analysis already completed. Students, in pairs, can help each other in graphing those amounts to show the trends over time in a visual manner. If student pairs have different companies, they can place their graphs around the room so the class can see how different companies perform visually. Independent Practice Provide students with two or three accounts from a comparative balance sheet or comparative income statement and have them calculate the trend or common‐size analysis and practice graphing the amounts. Summary
Review Ask students the following questions on exit tickets or using a matching activity. Question #1: What is horizontal analysis? Answer #1: It shows changes in amounts on financial statements over time. Question #2: Explain vertical analysis. Answer #2: Amounts on financial statements are compared to a total such as Total Assets or Total Sales. The ratio can still be tracked over multiple time periods, but the individual amounts are compared to a total on the same statement. Question #3: How is vertical analysis measured? Answer #3: It is measured in terms of percentages. Question #4: How is horizontal analysis measured? Answer #4: Horizontal analysis can be measured in terms of dollars or percentages. Question #5: How are percentage amounts calculated in horizontal analysis? Answer #5: The percentage amounts are calculated by subtracting the original period from the current period and dividing this amount by the amount in the original period, then multiplying by 100. Evaluation
Informal Assessment Any and all of the following can be used as informal assessments:  Exit tickets with vocabulary  Pair‐share activities  Class discussion and participation Copyright © Texas Education Agency, 2014. All rights reserved.
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Formal Assessment The following can be considered a formal evaluation in order to keep students engaged during both the pre‐
test(s) and post‐test(s):  Trend Analysis Assignment #1‐ In pairs, students will select a company to prepare a trend analysis. Locate a Comparative Balance Sheet and Income Statement for the company. Then the students will prepare a trend analysis for at least three accounts each from the company’s balance sheet and three accounts from the income statement. They should also include their own conclusion for each trend and a recommendation to management based on the increases or decreases they discover. They may prepare this on a spreadsheet program (or manually) and will present their findings to the class.  Common‐size Analysis Assignment #2‐ Individually, students will select a company and locate a Balance Sheet and Income Statement and prepare a vertical analysis of at least three items on each statement. These items are to be compared to a base amount which will equal 100% so that students will then create a pie chart for each of the two financial statements. Students will then make a conclusion and recommendation based on the results of the two pie graphs.  Trend Analysis Graph Assignment # 3‐ Students will locate the Comparative Balance Sheet or Comparative Income Statement for a company of their choosing. They will select at least five accounts for the statement they choose and create graphs for each account showing the change over the different time periods. They can follow a format similar to the one in the presentation or a format of their choosing— as long as a spreadsheet displays the changes in the five accounts across the time periods and five graphs total (one for each spreadsheet). They should make a statement about each of the analyses in order to make a possible recommendation to management. Enrichment
Extension Students will research a company and call that company to see if they can conduct an email interview with a financial analyst. The email interview should consist of three questions related to horizontal and/or vertical analysis and what they mean to the company. Report your findings in a one‐page report. Copyright © Texas Education Agency, 2014. All rights reserved.
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Horizontal and Vertical Analysis Financial Analysis Trend Analysis Assignment #1 Student Name _____________________________ CATEGORY 20 Content ‐ Accuracy All content throughout the presentation is accurate. There are no factual errors. Cooperation Pair delegates tasks and shares responsibility effectively all of the time. 15 8 1 Most of the content is accurate, but there is one piece of information that might be inaccurate. The content is generally accurate, but one piece of information is clearly flawed or inaccurate. Content is typically confusing or contains more than one factual error. Pair delegates Pair delegates tasks and shares tasks and shares responsibility responsibility effectively most of effectively some the time. of the time. Pair often is not effective in delegating tasks and/or sharing responsibility. Sequencing Information is Most information Some information There is no clear of organized in a is organized in a is logically plan for the Information clear, logical way. clear, logical way. sequenced. organization of information. Effectiveness Project includes all material needed to gain a comfortable understanding of the topic. Required Elements Project includes Project is missing Project is lacking most material more than two several key needed to gain a key elements. elements and has comfortable inaccuracies. understanding of the material but is lacking one or two key elements. Analysis contains Analysis is missing Analysis is missing Analysis contains at least three one account but two to three no accounts from contains accounts as well recommendations each of the recommendations. as the and is missing financial recommendations. more than three statements as accounts. well as recommendations to management. Maximum Points Possible: 100 Student Points: Copyright © Texas Education Agency, 2014. All rights reserved.
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Horizontal and Vertical Analysis Financial Analysis Common‐Size Analysis Assignment #2 Student Name _____________________________ CATEGORY 20 15 Content ‐ Accuracy At least six accurate facts are displayed on the document. Four to five Two to three accurate Less than two accurate facts facts are displayed on accurate facts are displayed on the document. are displayed the document. on the document. Knowledge Gained Student can Student can accurately accurately answer all answer 90% of questions related the questions to facts in the related to facts document and in the document processes used and processes to create the used to create document. the document. Student can accurately answer about 75% of questions related to facts in the document and processes used to create the document. Student appears to have insufficient knowledge about the facts or processes used in the document. Required Elements The document includes all required elements as well as additional information. All but one of the required elements are included on the document. Several required elements were missing. Graphics ‐ Relevance All graphs are All graphs are One graph relates to related to the related to the the topic. topic and make it topic and make easier to it somewhat understand. easier to understand. Graphs missing but calculations are present. Attractiveness The document is exceptionally attractive in terms of design, layout, and neatness. The document is distractingly messy or very poorly designed. It is not attractive. Maximum Points Possible: 100
8 All required elements are included on the document. The document is attractive in terms of design, layout, and neatness. The document is acceptably attractive though it may be a bit messy. 1 Student Points:
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Horizontal and Vertical Analysis Financial Analysis Trend Analysis Graph Assignment #3 Student Name _____________________________ CATEGORY 20 15 8 1 Content Accuracy All information provided by the student is accurate. 80% of the information provided by the student is accurate. 60% of the information provided by the student is accurate. There are several inaccuracies in the content provided by the student. Required Elements All the requirements of the assignment have been met. All except one to two of the requirements of the assignment have been met. All except three to four of the requirements have been met. Many of the requirements were not met. Learning of Material The student has an exceptional understanding of the material. Can easily answer questions about the content. The student has a The student has a Student did not good fair appear to learn understanding of understanding of much from this the material the material. Can project. Cannot included in the easily answer answer most site. Can easily most questions questions about answer questions about the content the content. about the content and procedures and procedures. used to make the website. Recommendations Clear Somewhat clear Somewhat Recommendations recommendations recommendations unclear that are present presented for presented for recommendations are not clear. each account each account presented for analyzed. analyzed. most accounts analyzed. Graphs Graphs are completely labeled. Maximum Points Possible: 100
Graphs are mostly Several labels Labels are missing labeled. missing from the from all graphs graphs. that are present. Student Points:
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