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limitation of horizontal and vertical analysis common sizing

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The benefit of vertical analysis is certainly the benefit of comparing companies of two different sizes. Looking beyond the numbers and focusing on the changes in the numbers can provide a seasoned analyst some very useful information about the company operational effectiveness.

The usefulness tends to breakdown when you come upon a company that has fluctuating amounts reported every quarter, every year. I once invested in a company that tended to receive most of its revenues through a competitive bid process. This company didn't have normal operations and its numbers routinely fluctuated based upon how often a new contract was received. Then the numbers were even more erratic when they reported their earnings based upon the work completed for each contract. Situations like this make it difficult to use horizontal and vertical analysis effectively.

So one limitation is fluctuating numbers. What are some of the other limitations of both horizontal and vertical analysis? Should one be used more than the other?

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Solution Summary

this solution lists in bullet format over a page of limitations of each and both of these techniques. 424 words total

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Evaluate the use of common size analysis and/or percent change analysis. List some of the limitations of the uses of using ratios.

1) An alternative approach to assessing the financial health and performance of a firm is to conduct a common size analysis or percent change analysis. Define each of these methods of evaluating firm performance.

2) Finally, present a few (i.e., three or four) of the limitations of uses of ratios and financial statement analysis

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