Comparative Financial Statements: Definition & Advantages

Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson, we'll define comparative financial statements. You'll also learn about the three advantages in constructing comparative financial statements: using percentages, analyzing trends, and comparing between different-sized companies.

What Are Comparative Financial Statements?

Julissa, the Chief Financial Officer of ABC Company, just returned from an accounting seminar where they discussed comparative financial statements. She rallies the financial professionals in her department and defines comparative financial statements for them as financial reports that include current and previous years' data and percentage changes for specific line items. Julissa mandates that the company use comparative financial statements going forward because they offer the following advantages.

Comparative Financial Statements
Comparative Financial Statements

Using Percentages Rather Than Raw Numbers

Julissa projects ABC's previous financial statements on the screen and shows how they used raw numbers to make decisions. For example, revenues for 2016, 2015 and 2014 were $500,000, $450,000 and $375,000, respectively. Due to the increase in revenue, the company had celebrated their success.

Julissa now asks the group to calculate the percentage change year over year by using the following formula: ((current year - previous year)/previous year))*100. The group returns a percentage of 20% for 2015 and 2014 revenues, and 11% for 2016 and 2015.

Julissa asks the financial professionals in the meeting why the company was celebrating, and they give her the obvious answer: revenues increased. Julissa explained that although revenues increased year over year, they increased by a smaller percentage in 2016. Furthermore, ABC had promised investors revenues would increase by 25%. Using comparative financial statements shows that maybe they shouldn't have been celebrating because they actually missed the mark.

Now Julissa announces that they're going to explore how comparative financial statements can help financial professionals understand trending.

Analyzing Trends

Julissa tells the meeting that using percentages rather than raw numbers can also give them more information about trends in ABC's financial statements. Trends can be identified when we analyze specific line items over a period of time using percentages. When the percentage remains the same, the company is maintaining status quo. If the percentage increases, ABC is growing, which is positive news if we're referring to revenues (sales) or assets (ownership). However, increased percentages in expenses (costs) or liabilities (obligations) could be a cause for concern. Similarly, a decreasing percentage suggests a decline and in the wrong account such as revenues and assets, this could signal financial trouble.

Julissa polls the group for questions, and one of her subordinates asks how can comparative financial statements help with competitor analysis.

Competitor Analysis

Julissa explains that ABC's main competitor, XYZ, claimed revenues of $425,000 in 2016, which is lower than ABC's revenues. Julissa notes that ABC celebrated again. But now she wants the group to review XYZ's previous income statements and calculate the percentage change in revenue over 2016, 2015 and 2014.

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