FA 50 - Horizontal Analysis
Summary
TLDRThis video script offers a detailed explanation of horizontal analysis in financial statement evaluation. It demonstrates how to compare two consecutive years to identify significant changes in a company's performance. The script illustrates the process by examining sales, cost of goods sold, gross profit, operating income, and other financial figures, highlighting the importance of year-over-year percentage changes for a more insightful analysis. The presenter emphasizes the need to investigate any discrepancies, such as a higher increase in cost of goods sold compared to sales, to understand underlying business dynamics.
Takeaways
- đ The video discusses how to perform a horizontal analysis on financial statements by comparing one year to the next.
- đ Horizontal analysis involves looking for significant changes in numbers between two consecutive years to understand the company's performance trends.
- đ The speaker emphasizes the importance of identifying big numbers with large changes as they can quickly reveal insights about a company's financial health.
- đ The example given in the script shows a comparison of sales, cost of goods sold, gross profit, operating expenses, operating income, interest expense, income before tax, income taxes, and net income between 2023 and 2024.
- đ The speaker points out that while most items increased, the interest expense decreased, which might be related to changes in long-term debt rather than operational performance.
- đ Percentage change is highlighted as a more useful measure than absolute change, as it provides a relative comparison to the previous year's figures.
- 𧟠To calculate the percentage change, the change in value is divided by the value of the earlier year, which gives a more meaningful insight into the company's growth or decline.
- đ€ The speaker suggests that comparing percentage changes can be more informative than absolute changes, especially when comparing companies of different sizes or in different industries.
- đš A key concern raised in the script is the cost of goods sold (COGS) increasing at a higher rate than sales, which could indicate a potential issue with pricing strategy or cost management.
- đ The speaker recommends investigating why COGS increased at a higher rate than sales, as this discrepancy could impact the company's profitability and margins.
- đ The takeaway emphasizes the importance of horizontal analysis as a fundamental tool for quickly understanding and evaluating a company's financial performance over time.
Q & A
What is the main focus of the video script?
-The main focus of the video script is to explain the concept of horizontal analysis in the context of financial statements, using the example of a company's sales and other financial figures from two consecutive years.
Where can the workbook containing the problems discussed in the video be found?
-The workbook can be found on a website mentioned in the script, where one can click the PDF link to download a copy of the problems.
What does the term 'horizontal analysis' refer to in the context of the video?
-In the context of the video, 'horizontal analysis' refers to the process of comparing financial statements from one year to the next, to identify changes and trends in the company's financial performance.
How does the video script suggest identifying significant changes in financial statements?
-The script suggests identifying significant changes by eyeballing the statements for big numbers with big changes, which can quickly tell a story about the company's financial performance.
What is the difference between horizontal and vertical analysis in the context of financial statements?
-Horizontal analysis involves comparing financial figures across different years to identify year-over-year changes, while vertical analysis compares figures within the same year to understand the proportionate relationship between different line items.
What is the significance of calculating percentage change in financial analysis?
-Calculating percentage change is significant as it provides a relative measure of change, allowing for better comparison of performance across different time periods and between companies of varying sizes.
How does the video script define the year-over-year change in sales?
-The year-over-year change in sales is defined as the difference in sales figures between two consecutive years, in this case, from 2023 to 2024.
What is the importance of comparing similar competitors when analyzing financial performance?
-Comparing similar competitors is important to benchmark the company's performance against industry standards and to understand how effectively the company is performing relative to its peers.
Why might a company's cost of goods sold (COGS) increase at a higher rate than its sales?
-A company's COGS might increase at a higher rate than its sales due to various factors such as increased production costs, higher input prices, or a change in the product mix that results in lower profit margins.
What does the video script suggest as the most concerning figure in the financial analysis presented?
-The script suggests that the most concerning figure is the cost of goods sold (COGS) increasing at a higher rate than sales, which indicates a potential issue with profit margins and cost management.
How does the video script recommend further investigation of the financial figures?
-The script recommends investigating the reasons behind significant changes, such as why COGS increased at a higher rate than sales, by examining factors like pricing strategies, cost management, and market conditions.
Outlines
đ Horizontal Analysis of Financial Statements
This paragraph introduces the concept of horizontal analysis in financial statement evaluation. The speaker explains that horizontal analysis involves comparing one year's financial data to the next, rather than analyzing the components of a single year's statement. The example of the L key company is used to demonstrate how to identify year-over-year changes in sales, cost of goods sold, gross profit, operating expenses, operating income, interest expense, income before tax, income taxes, and net income. The speaker emphasizes the importance of looking at significant changes in numbers to quickly understand a company's performance. The paragraph concludes with a discussion on the usefulness of percentage changes in providing a more meaningful comparison, especially when comparing companies of different sizes or against industry peers.
đ Deep Dive into Cost of Goods Sold and Profitability
In this paragraph, the focus shifts to a more detailed examination of the cost of goods sold (COGS) and its impact on profitability. The speaker points out that while an increase in sales is positive, a disproportionate increase in COGS could indicate a problem. Using the L key company's data, the speaker calculates the percentage change in sales and COGS, noting that COGS increased at a higher rate than sales, which could be a concern. The speaker suggests that this discrepancy warrants further investigation, such as examining whether price reductions led to squeezed margins or if there were general cost increases. The paragraph also touches on the importance of comparing these figures with industry competitors to assess a company's performance relative to its peers.
Mindmap
Keywords
đĄHorizontal Analysis
đĄFinancial Statements
đĄYear-Over-Year (YOY)
đĄSales
đĄCost of Goods Sold (COGS)
đĄGross Profit
đĄOperating Expenses
đĄOperating Income
đĄInterest Expense
đĄIncome Before Tax
đĄNet Income
đĄPercentage Change
Highlights
The video introduces a counting workbook available for download from a website.
There are more videos on the website than listed on YouTube, including both public and members-only content.
The workbook covers every problem with either a public or members-only video explanation.
Horizontal analysis is explained as comparing one year to the next in financial statements.
A hand gesture is used to illustrate the concept of horizontal analysis.
The importance of horizontal analysis in quickly understanding significant changes in a company's financials is emphasized.
Sales grew from $151,000 to $168,000, indicating a year-over-year increase.
The concept of percentage change is introduced to provide a more meaningful comparison.
Sales increased by 11.3% year-over-year, providing a clearer picture of growth.
Cost of goods sold (COGS) increased by 15.4%, which is a higher rate than sales growth.
Gross profit, operating expenses, and operating income all show an increase, but at varying percentages.
Interest expense decreased by 33%, which may be related to changes in long-term debt.
Income before tax, income taxes, and net income all show an increase, indicating overall financial health.
The importance of comparing percentage changes with industry peers is discussed for context.
A significant insight is that COGS increased at a higher rate than sales, which could impact profitability.
Investigating the reasons behind the higher rate of COGS increase compared to sales growth is suggested.
The video concludes with a call to action to stay tuned for the next video in the series.
Transcripts
the problem from this video can be
downloaded at a Counting workbook calm
if you go to the website click the PDF
link and you can download a copy of this
and all of my problems for yourself now
if you check the website and you click
on videos you'll see there are more
videos than those I've listed publicly
on YouTube you can see that there's
every problem covered in the workbook
has either a public video or a
members-only video if you'd like access
to the members only video just click the
join button beneath the video player on
YouTube alright let's jump into the
problem let's examine problem 12:1 a
this has us doing a horizontal analysis
now just wherever you are in your seat
right now give me like a hand gesture
for horizontal ok have you done it just
with your hands show me what horizontal
looks like horizontal looks like this
doesn't it not like this not like
up-and-down horizontal looks like kind
of like that
well horizontal analysis has us
analyzing financial statements like this
what does it mean well if we look at
this L key company and look at its
financial statements horizontal means
were comparing one year to the next
right we're comparing two years to each
other we're not looking up and down the
statement to compare o what's our sales
versus our cost of goods sold no no
we're comparing 2023 sales to 2024 sales
this is so fundamental right when I
analyze a company this is one of the
first things I do just I eyeball it and
I look for big numbers that had big
changes so I'll look and I'll say oh you
know what we're our year over your sales
Oh our sales grew right you can just
eyeball this and you can say Oh
horizontally my sales grew from 151 to
168
they grew by $70,000 already I'm saying
something intelligent I can do our sales
were up $17,000 how much were they up
the year before you know they were up
50,000 a year before only 17 this year
that's not great you already know
something about the company very quickly
right big numbers with big changes tell
you a story about a company so that's
what a horizontal analysis sets out to
do and this is the most basic horizontal
analysis
I put a triangle there I'll put it in
black ink triangle means change
and so our year-over-year change here is
all we want to do so 151 to 168 means
it's a change of plus $17,000 right our
sales are up $17,000 our cost of goods
sold up 12,000 our gross profit up 5,000
our operating expenses are up to our
operating income up 3 our interest
expense down a thousand our income
before tax up 4,000 our income taxes are
up a thousand and our net income is up
3,000 so already we've kind of learned
something right we've learned okay most
things are up interest expenses down
that might be related that is related to
long-term debt more than any financial
performance so the change is relevant
but what's even more useful and you'll
see this stated very commonly is the
percentage change year over year so to
compute a percentage change you just
take that change number and divide by
the earlier year so for example for my
sales that change was 17,000 I'm gonna
divide by the sales of the earlier year
1 5 100 and I'm gonna say hey my sales
are up eleven point two actually eleven
point three
I'm around in the wrong way here 11.3%
my cost of goods sold 12,000 / 78 15.4%
my gross profit 5 / 73 my gross profit
is up 6.8% my operating expenses up 6.7%
my operating income six point nine seven
percent 7.0 percent I guess that rounds
to
my interest expense 1/3 it's down 33% 33
and 1/3 4/4 t I can already tell you
that that's up 10 point o % I didn't put
pluses here but these are all
up-up-up-up-up
income taxes are also up 10% and our
profits up 10% ok so again we can say
something intelligent our sales are up
11% that compares the last year sales
which were increased by 20% you know you
can compare things by percentages and
again it's it's useful like saying you
know if I told you my company sales are
up $17,000 it doesn't mean much because
you don't know the size of the company
if I say oh my company's sales are up
10% or 11.3% you get a better feel and
you don't look at it in a vacuum I would
say okay I'm looking at home depot or
lowes you know there's very similar
companies Home Depot sales were up 15%
low sales were up by 9 percent well Home
Depot outperformed Lowe's right where
you know maybe Amazon sales were up 30%
and they're just not comparable I would
want to compare two similar competitors
okay which items would I call out if I
were if I were analyzing this company if
I were the operator here I would be
actually be most concerned with this one
that would be the number I'd be calling
out I'd say look sales are up 11% but
cogs are up 15 we should have been way
more profitable we generated 11% more
sales but only 7% more gross profit and
the reason was our costs were up why
were our cost a bit slowed up did we
have to reduce our prices and therefore
our margins got squeezed was there where
our costs just up generally maybe we
should raise the prices what's going on
that cogs was up at just a higher rate
than everything else so that would be
the number that I might investigate you
might think well I should investigate
the interest expense this wouldn't take
much investigation I think you would
look at the debt and you could see the
terms of the debt were likely better or
you just had less debt
being serviced but do the alarming
number from investor's standpoint or the
number that you'd be worried about is
that one cogs being up at a higher rate
than ourselves we would expect you know
you sell 10% more stuff guess what your
cost of goods sold should go up by ten
percent well we saw the 11 percent more
stuff our cost of goods sold was up 15%
this is significant and worth
investigating ok that's it for this
video stay tuned for the next one
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