In horizontal analysis, each item is expressed as a percentage of the
- Stockholders equity amount
- Total assets amount
- Base year amount
- Net income amount
The Correct Answer Is
c. Base year amount
Correct Answer Explanation: c. Base year amount
Horizontal analysis is a financial analysis technique used to evaluate changes in financial statement items over a period of time. When expressing each item as a percentage, it’s crucial to choose a base against which these percentages are calculated.
The correct answer among the options provided, “c. Base year amount,” signifies that in horizontal analysis, each item is expressed as a percentage of the base year amount.
Choosing the base year amount as the reference point for calculating percentage changes is a fundamental aspect of horizontal analysis. It allows for a comparison of how individual line items in financial statements have changed relative to a specific point in time, usually a past year considered as the base.
This method facilitates a clearer understanding of the trends and variations in financial data across consecutive periods.
Now, let’s delve into why the other options provided Stockholders’ equity amount, Total assets amount, and Net income amount are not correct as the base for expressing percentages in horizontal analysis:
a. Stockholders’ Equity Amount:
Stockholders’ equity represents the residual interest in the assets of an entity after deducting liabilities. Using this as a base for expressing percentages in horizontal analysis would limit the evaluation to changes relative to the equity portion alone.
While changes in relation to equity could be valuable, it wouldn’t provide a comprehensive understanding of how other crucial elements in financial statements have evolved over time.
For instance, if a company experienced significant changes in assets or liabilities but only analyzed these changes in relation to stockholders’ equity, it could overlook important shifts in the financial health or structure of the organization.
b. Total Assets Amount:
Total assets encompass all resources owned by a company, including both current and non-current assets. Using total assets as the base for expressing percentages in horizontal analysis would primarily reflect changes concerning the size and composition of assets.
However, this method would not give a clear picture of changes in other critical areas such as revenues, expenses, or profitability. Horizontal analysis aims to evaluate changes across various financial elements, and focusing solely on assets might not provide a comprehensive view of the overall financial performance and position.
d. Net Income Amount:
Net income represents the profit or loss generated by a company during a specific period after deducting expenses from revenues. While net income is a crucial metric for assessing profitability, using it as a base for expressing percentages in horizontal analysis could be misleading.
Expressing other financial statement items as percentages of net income might not effectively capture changes in assets, liabilities, or equity. It could obscure important fluctuations in operational efficiency, cost management, or capital structure, which are critical for a comprehensive financial analysis.
In contrast, using the base year amount as the reference point in horizontal analysis allows for a holistic comparison of various financial statement items over time.
It offers a standardized benchmark, facilitating a comprehensive assessment of changes in assets, liabilities, equity, revenues, expenses, and other key financial metrics relative to a specific historical period.
By selecting the base year amount, analysts can accurately identify trends, patterns, and variations in financial data, aiding in decision-making processes for investors, stakeholders, and management.
This approach provides a more robust understanding of how each financial item has evolved compared to a chosen historical period, ensuring a comprehensive evaluation of a company’s financial performance and position.
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I am Smirti Bam, an enthusiastic edu blogger with a passion for sharing insights into the dynamic world of business and management through this website.
I hold a MBA degree from Presidential Business School, Kathmandu, and a BBA degree with a specialization in Finance from Apex College,
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