Analysis of the Operation and Financial Condition of the Enterprise

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Analysis of the Operation and Financial Condition of the Enterprise review of the balance sheet items, the respective disclosures and theirconformity; clarification of the most ‘critical’ items (losses, overdue liabilities, high level ofdebtors from total assets, high percentage of liabilities compared to the level ofdebtors); checking compliance between the balance sheet and income statement (accordingto the amounts of retained earnings, building up of reserves); review of the income statement items and their comparison with the disclosures. Vertical and horizontal financial analysisThe main functions of the enterprise assets are as follows: provision and extension ofthe enterprise business operations and securing the fulfilment of the enterprise liabilities. Theamount and structure of enterprise assets are influenced by several factors: Enterprise size, area of operations and its goals; Technologies applied; Efficiency considerations; Marketing considerations; Type of sales organisation.The position of the enterprise capital is reflected in the accounting statement of theenterprise - its balance sheet. The capital structure and composition of an enterprise ischanging, they are affected by the business transactions performed.By analysing the position, the structure and the changes of the enterprise capital, thehorizontal and the vertical balance sheet analysis is used. Vertical analysisThe vertical balance sheet analysis shows the resources of the enterprise and thechanges in the structure of its sources in percentage by taking the total balance sheet amountas the base which is equal to 100 %.The vertical or structural analysis allows analysing the changes in the structure of theobject of research over a certain period as well as in comparison with the budget. The purposeof vertical analysis is as follows: Gives a notion of the accounting statements – in the form of relative values thatcharacterise the balance sheet and the structure of the profit and loss account; Allows to assess the fairness and correctness of the enterprise annual report; Points out the ‘problematic’ areas in the operations of an enterprise and enablesthe preparation of a further action plan.In other words, vertical analysis is the percentage of some financial statement itemsfrom the total assets or liabilities, respectively, and other total indicators, as well as thestructural changes of some balance sheet and income statement items. Analysis isexpressed in the form of ratios. According to this method an object is assumed to be100 %, and from this the relation between some sections and the total amount of theobject is determined by thus making up the structure of the object. In performance ofthe balance sheet vertical analysis all balance sheet items are expressed in percentagesagainst the total amount of the balance sheet, while in performing the income42
Analysis of the Operation and Financial Condition of the Enterprisestatement vertical analysis all items are expressed against the amount of revenues andcosts. Horizontal analysis – the relative and absolute changes in various items of thestatements compared to the preceding period or any other base periods areidentified. By using this method it is possible to analyse both indicators during thechange period and the variance of the indicators compared to the base period. Themethod of dynamics shows the trends of changes in the indicators under review andgives the possibility in the course of analysis to study the influence of differentfactors on the changes in the given indicators and to determine their value.Horizontal analysis is based on the golden rules of the balance sheet. The balancesheet golden rules are not mandatory; these are recommendations on how to do thefinancing of assets.Three golden rules of the balance sheet exist:1. Equity – long-term investments = deviation(2.1)This means that it is desirable to cover long-term investments by equity (equityis held by an enterprise for an unlimited period of time).2. (Equity + long-term liabilities – long-term investments = deviation(2.2)Long-term investments should be covered by equity and long-term liabilities,because the long-term liabilities are due in one year and more.3. Short-term liabilities – Working capital = deviation (2.3)This means that working capital should be covered by short-term liabilities.The basic idea of the horizontal or dynamic analysis method is to compare the values ofthe indicators under review with the values of the same indicators in the preceding period (thebase period) or with the values included in the budget.Horizontal analysis: Gives an idea of the enterprise rate of growth, the proportion between thegrowth rates of the enterprise income and expenditure; Allows to clarify the trends of development of the enterprise and their cyclicalnature, the influence of internal and external factors on enterprise performanceresults; Allows to asses the efficiency of growth in the turnover of an enterprise inrelation to its financial status.The dynamic or horizontal analysis shows the trends of changes in the indicators underreview and gives the possibility in the course of analysis to study the influence of differentfactors on the changes in the given indicators and to determine their value. This type ofanalysis can be carried out as certain changes in some balance sheet items in absolute andrelative figures (percentages) when the indicators of the reporting period are compared to theprevious period or any other base indicators. Changes are analysed with the help of thedynamics index or in percent.Horizontal variances of the financial indicators are expressed as follows:Dynamics index (DI) = Reporting period indicator/base period indicator (2.4)43
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Analysis of the Operation and Financial Condition of the Enterprise

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