Vertical and Horizontal Analysis and Indices in the Balance Sheet

14/07/26 •0•0

Let's look at what types of information we can extract from the balance sheet and how to analyze it

Автор:Leon

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Horizontal Analysis

A simple way to analyze an entity is by examining the behavior of a given item in the financial statement in evolutionary terms over time or in comparison with another account.

	Year 1	Year 2	Year 3
Revenue	R$ 350,000	R$ 400,000	R$ 480,000
Assets	R$ 200,000	R$ 210,000	R$ 240,000

As you can see, over the last three fiscal years there has been growth in both revenue and total assets. Horizontal analysis allows us to determine the extent of this growth. However, for calculation purposes, it is necessary to choose a base date. This may be the first year of information. Thus, we can say that revenue grew by 14.29% over a one-year period and by 20% in the second year.

At the same time, total assets also grew, but at a lower level: 5% and 14.29%. This is a sign that the company is managing to use its assets better to generate revenue.

Vertical Analysis

Vertical analysis usually corresponds to participation analysis. In general, we use total revenue and total assets as parameters. Thus, for each item on the balance sheet, its share of total assets is calculated; the same is done with each item of the Income Statement in relation to revenue.

	Year 1	Year 2	Year 3
Current Assets	31%	32%	39%
Non-Current Assets	69%	68%	61%
Current Liabilities	18%	20%	25%
Non-current liabilities	20%	20%	24%
Equity	62%	60%	51%

Based on this information, we can see that over time there was an increase in the share of current assets over total assets. On the right side, there was an increase in short-term and long-term debt, offset by a reduction in equity. In other words, the company is more indebted. See the table below, which shows the vertical analysis values for the accounts in the Income Statement.

	Year 1	Year 2	Year 3
Administrative Expenses	24%	25%	26%
Salary Expenses	25%	27%	28%
Energy and Telephone Expenses	6%	6%	6%
Consumable Materials Expenses	10%	10%	9%
Depreciation Expenses	6%	7%	6%
Other Expenses	5%	5%	1%
Financial Expense	5%	5%	1%
Financial Expense	6%	7%	7%
Net Profit	14%	11%	12%

Also, considering the vertical analysis of the Income Statement, we can identify that net profit decreased from 14% to 11% in the period from 2006 to 2007. In the following period, profit increased from 11% to 12% in relation to revenue. And the main accounts in the Income Statement, Administrative Expenses and Salaries, increased their share in relation to revenue, justifying the reduction in profitability.

Types of Indicators

There are 10 types of indicators that we can use to assist us in auditing a company:

- Structure ratio. The class of “structure ratios” includes all the main ratios used for capital structure analysis, or for the analysis of capital soundness.

- Debt ratio. The most widely shared financial practice performs analysis of long-term capital soundness or solvency not only by evaluating the degree of balance of structural capital (structure ratios), but also the degree of financial balance and, therefore, the degree of indebtedness.

- Coverage ratio. It is the ratio between financial reserves and monthly expenses. It measures the amount of time it will be possible to maintain a standard of costs, expenses, and interest payments over a given period, commonly used in months.

- Liquidity ratio. Liquidity analysis is used to assess the company’s solvency rating, as these indicators aim to show the company’s degree of effective liquidity, that is, its ability to meet short-term and long-term debts.

- Financial ratios. This class of financial indicators expresses the financial flows generated by the company and makes it possible to understand the company’s financial and equity structure.

- Profitability Indicators. The analysis of the company’s financial statements to understand profitability, that is, how much must be invested to obtain 1 real of profit, for example.

- Turnover Indicators. The class of turnover ratios is designed to provide an additional set of ratio data to the creditor community, supporting them in monitoring the company’s general activity by calculating Asset Turnover and the company’s operating cycle from one year to another, calculating the turnover of other important indicators such as working capital.

- Productivity Ratios. Seeks to understand the relationship between the number of employees or salary value and the company’s revenue.

- Cost-Effectiveness Ratios. Seeks to understand the company’s effectiveness, the cost of labor or cost of production, for example.

- Growth Ratios. Seeks to identify variations in costs, revenue, production, etc., in order to understand whether the company is growing or shrinking.

We will not examine all the ratios in depth here, but we will look at some of them.

Liquidity Indicators

Liquidity concerns how quickly the company can transform resources into currency. It is a very important concept, and generally low liquidity is associated with higher levels of risk. For this reason, liquidity ratios are often used for bankruptcy prediction, bank credit granting, and even supplier selection.

We generally calculate it by dividing assets by liabilities. If general liquidity is greater than 1, it is understood that the company has sufficient available capital to meet all its obligations. If general liquidity is equal to 1, capital and obligations are equivalent. If general liquidity is less than 1, it means that the company does not currently have sufficient capital to meet all its obligations.

Current Liquidity

This ratio shows whether short-term assets are greater or less than short-term liabilities. When the value obtained is greater than one, this means that current assets are greater than current liabilities. Otherwise, that is, when the value is less than 1, short-term assets are less than short-term obligations.

\[ \text{Current Liquidity} = \frac{\text{Current Assets}}{\text{Current Liabilities}} \]

Quick Liquidity

Quick Ratio is an index very similar to the Current Ratio. The difference is that items with lower liquidity are not considered in current assets. There is some disagreement among authors regarding the calculation method. Some exclude only prepaid expenses; others, fewer in number, also exclude inventories; and there are some who exclude only inventories. We will use the following expression here to calculate the quick ratio:

\[ \text{Quick Ratio} = \frac{\text{Current Assets - Prepaid Expenses}}{\text{Current Liabilities}} \]

Immediate Liquidity

Immediate Liquidity relates the company’s most liquid resources, cash and cash equivalents, to short-term debts. See below:

\[ \text{Immediate Liquidity} = \frac{\text{Cash and Equivalents}}{\text{Current Liabilities}} \]

This index indicates how much of current liabilities can be paid immediately with the resources available in the company’s cash.

General Liquidity

General liquidity considers not only short-term items, but also long-term items that may be converted into cash in the future. The calculation expression is as follows:

\[ \text{General Liquidity} = \frac{\text{Current Assets + Long-term Receivables}}{\text{Current Liabilities + Non-current Liabilities}} \]

For this case, we need to understand the four types of financial assets: current assets, non-current assets, short-term realizable assets, and long-term realizable assets.

- current assets: those that refer to financial transactions, such as payments, inventory, cash flow, etc.;

- non-current assets: the company’s assets and rights that do not involve transactions, such as vehicles, machinery, land, etc.;

- short-term realizable assets: current amounts, realizable rights, or assets maturing by the following year;

- long-term realizable assets: those that refer to transactions similar to current assets, but with a completion or realization period of at least one year.

Example with Liquidity Ratios

	Year 1	Year 2	Year 3
Current Ratio	1.72	1.58	1.59
Quick Ratio	1.52	1.42	1.45
Immediate Liquidity	0.17	0.21	0.20
General Liquidity	0.82	0.8	0.8

Debt Ratios

We use these ratios to study the composition of the entity’s liabilities. The interest is to verify the level of indebtedness and the sources of funds used.

Relationship Between Third-Party Capital and Equity Capital

This ratio relates total third-party capital, represented by current liabilities and non-current liabilities, to shareholders’ equity:

\[ \text{TC/EC Ratio} = \frac{\text{Current Liabilities + Non-current Liabilities}}{\text{Shareholders’ Equity}} \]

Debt Structure

The debt structure ratio helps to better understand the behavior of the company’s debt, separating short-term resources from long-term resources. Its value is obtained through the following relationship:

\[ \text{CL/NCL Ratio} = \frac{\text{Current Liabilities}}{\text{Non-current Liabilities}} \]

Capital Structure Indicators

\[\text{Fixed Assets Over Non-recurring Resources} = \frac{\text{Permanent Assets}}{ \text{Non-current Liabilities}}\]

\[\text{Total Debt/Equity} =\frac{ \text{Total Debt} }{ \text{Shareholders’ Equity}}\]

\[\text{Equity Capital Participation} = \frac{\text{Equity Capital} }{ \text{Total Assets}}\]

Exercises

1) (FUNDATEC - Restinga Seca City Hall - Accountant - 2022) Economic and financial indicators are tools that enable the detailed analysis of aspects according to the needs of the user of accounting information. In this regard, select the indicator that corresponds to one of the ratios in the profitability group.

A) Current ratio.

B) Return on equity rate.

C) Percentage of equity capital.

D) Quick ratio.

E) Vertical analysis.

2) (IESES - Gas Brasiliano - Junior Economist - 2017) Financial management is strongly concerned with the concepts of liquidity and profitability. The professional who is most concerned with liquidity is the:

A) Shareholder.

B) Controller.

C) Auditor.

D) Treasurer.

3) (UFF - UFF - Auditor - 2012) Among management indicators, the one that shows management’s attention to the proper use of financial resources, which are by definition scarce, from the adequacy of the budget proposal to the goals to be achieved, through consistency with market prices, the development of alternative revenue sources, and the achievement of the lowest costs per product generated, is called:

A) economy;

B) effectiveness;

C) efficacy;

D) selectivity;

E) essentiality.

4) (CESPE/CEBRASPE - ABIN - Technical Intelligence Officer - Accounting Sciences Area - 2010) Judge the following items, referring to the general concepts of public accounting. The main function of accounting indicators is to enable the automatic recording of accounting events based on information from a specific numerical code. Right or wrong?

5) (CESPE/CEBRASPE - EMBASA - Sanitation Analyst - Administration Area - 2009) Judge the following items regarding the Fiscal Responsibility Law (LRF) and financial, economic, and equity indicators. To obtain a measure of operational efficiency, the return on investment (ROI) ratio can be used. In order to interpret the evolution of this indicator, two pieces of information must be obtained, which are its own components: gross income divided by total investment. Right or wrong?

6) (FUNDATEC - 2023 - IF Farroupilha - RS - Accountant) To answer the question, consider the information collected from the WAZ Institute, dated 12/31/2019.

Account	Balance (in R$)
Current Assets	250,000.00
Non-current Assets	425,000.00
Inventories	50,000.00
Prepaid expenses	22,000.00
Current Liabilities	333,000.00
Non-current Liabilities	132,000.00
Shareholders’ Equity	210,000.00
Net Income	190,000.00
Net Sales	522,000.00

Based on the information from the WAZ Institute, the third-party capital participation ratio, on 12/31/2019, was:

A) 0.88.

B) 1.00.

C) 1.58.

D) 2.21.

E) 3.11.

Solution

1) B

2) D

3) A

4) Wrong

5) Wrong

6) D

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Leon

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