3 Types of Financial examination and When They Matter

Financial examination is conducted using information posted on a business’ financial statements to estimate the current financial position and the past performance.

Financial meaningful performance indicators such as liquidity, profitability, and solvency among others highlighted by this course of action are used to ascertain the financial strengths and weaknesses of the business entity.

This examination can be performed internally within the organization to ease decision making by management. External parties and stakeholders such as auditors, regulators, financial analysts, investors, and competitors can also conduct their examination using the obtainable facts to ascertain the entity’s financial position. These stakeholders equally utilize the information for decision-making appropriate for their respective interests.

Three types of financial analyses can be performed with businesses financial statements are horizontal examination, vertical examination, and ratio examination.

  1. Horizontal examination

Horizontal examination of financial information entails the assessment and comparison of the relative changes in specific items in a financial statement over stipulated accounting periods. The items in question could be sales, revenue, etc., and the accounting periods can be months, quarters, years, etc.

This kind of financial examination is best applied when seeking to determine the dynamic behaviour of an item so as to observe the trend of the item over the stated accounting periods. This is important in calculating the factors behind the trend, whether positive or negative. For example, the net profit of a business can be tracked over a five-year period.

However, there are two ways of conducting a horizontal examination, namely; percentage examination and absolute examination.

In the absolute examination, the comparisons are carried out using the figures posted in the financial statements while in percentage examination, the comparisons require presenting the relative change in the figures into percentages.

  1. Vertical examination

Also known as the shared-size examination, this vertical examination involves comparison of figures of separate items to a standard figure on the balance sheet over a stated accounting period. For example, taking the total revenue of an accounting period to be 100%, other items such as employee benefits and debt repayment for a particular period can be calculated as percentages against the total revenue of the specific accounting period.

This form of examination is most useful in the determination of the efficiency of business items by comparing how they stack up against shared items such as income.

  1. Ratio examination

This method of financial examination correlates the different items of a balance sheet to the income statement to determine the financial performance of the firm. Assets are measured against limitations and presented in a simpler way that is comprehensible without quoting huge figures.

Ratio examination matters most when analysts and stakeholders seek to determine the viability and sustainability of an entity’s long-term and short-term financial strategies.

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