What is Account Analysis in Accounting: Charges and Example

Introduction

One of the primary aspects of diligent financial management is account analysis. It involves a detailed analysis of various financial accounts to ensure accuracy and get valuable insights into the company’s financial health. 

Thorough review of the financial statement allows businesses to detect discrepancies, prevent fraud, and make informed strategic decisions. This rigorous process not only enhances transparency but allows for better financial planning and resource allocation.

Understanding account analysis is crucial for anyone involved in financial management or decision-making. In this blog, we will discuss the basics of account analysis, its various types, practical applications, and much more.

What is Account Analysis?

Account analysis is the process of examining the detailed line items of an account and its financial statements to identify trends and anomalies. It helps businesses gauge the financial performance of business accounts to ensure the accuracy of financial statements & is critical for proper financial reporting and decision-making.

Performed periodically, it helps to monitor financial health and take corrective actions if required. By helping organizations understand their revenue streams, expenses, and overall financial position, account analysis enables them to detect errors, prevent fraud, and ensure compliance with financial regulations. For instance, a company might detect a sudden increase in accounts payable during account analysis, which can prompt them to analyze further and identify the root cause of this spike.

Types of Account Analysis

Horizontal and vertical analysis are two of the most commonly utilized account analysis methods. These techniques allow businesses to view financial statements from totally different perspectives, enabling one to understand the financial performance and condition of a company as a whole. Let us understand these methods in detail:

1. Vertical analysis

Vertical analysis involves analyzing the items in financial statements in relation to some base figure within the same statement. Every item can be stated as a percentage of the selected figure. For example, in an income statement, each expense item is shown as a percentage of total sales. This brings out the proportionate relationship of each item within the financial statement.

Vertical analysis enables businesses to:

• Identify Cost Structures
  Understand the relationship of various expenses to total sales that helps in pointing out areas where costs could be controlled or optimized.
• Compare Performance
  Assess financial performance over different periods or against industry benchmarks to identify significant variances.
• Detect Trends
  Observe shifts in the relative size of different accounts over time, which may indicate changes in business operations or financial strategy.

2. Horizontal Analysis

This technique focuses on comparing financial data over multiple periods. By examining trends and changes in financial statement items from one period to another, businesses can identify growth patterns, seasonal variations, and potential financial issues. Horizontal analysis is crucial for long-term financial planning and performance evaluation.

Through horizontal analysis, a business is able to:

• Monitor growth
  Calculate the rate of growth of revenues, expenses, and profits over some time to determine the expansion and success of the business.
• Analyze Variability
  Identify consistent trends or inconsistencies in the financial performance, pointing to areas that could be a cause for concern and take remedial measures
• Show Future Performance
  Use historical trends to project future financial performance and support strategic planning and decision-making.

Advantages of Account Analysis in Accounting

Account analysis helps businesses maintain the accuracy of financial reporting, identify trends, and consequently make decisions based on those trends. Proper understanding s of account analysis can benefit companies looking to leverage this process in order to gain better budgeting, forecasting, internal controls, performance evaluation, and strategic decision-making.

Account analysis serves multiple purposes in the realm of accounting. Here are some of the key advantages:

1. Financial Reporting: Ensures that financial statements are accurate and compliant with accounting standards.
2. Budgeting and Forecasting: Helps in creating realistic budgets and financial forecasts by providing a clear picture of past and present financial performance.
3. Internal Controls: Identifies discrepancies and errors, thus enhancing the effectiveness of internal controls and reducing the risk of fraud.
4. Performance Evaluation: Assists in evaluating the financial performance of different departments or business units, enabling better resource allocation.
5. Decision-Making: Provides critical insights that inform strategic decisions, such as investments, cost-cutting measures, and growth strategies.

Example of Account Analysis

To illustrate the process of account analysis, let’s consider an example where Company ABC wants to analyze its financial performance over the past three years using both horizontal and vertical analysis methods. This will help us understand both methods in a practical manner and will show the calculation:

• Revenue Analysis (Horizontal Analysis)
  Company ABC’s income statements for the last three years show the following revenue figures:

  Year 1: $1,000,000
  Year 2: $1,200,000
  Year 3: $1,500,000

  By conducting horizontal analysis, we can calculate the year-over-year growth rates:

  Year 2 vs. Year 1: (($1,200,000 – $1,000,000) / $1,000,000) * 100 = 20% growth
  Year 3 vs. Year 2: (($1,500,000 – $1,200,000) / $1,200,000) * 100 = 25% growth

  This analysis indicates a steady increase in revenue, with an acceleration in growth from Year 2 to Year 3.

• Expense Analysis (Vertical Analysis)
  For illustrative purposes, let’s evaluate the proportion of marketing expenses relative to total sales for Year 3 using the vertical analysis method:

  Let us consider
  Total Sales (Year 3): $1,500,000
  Marketing Expenses (Year 3): $300,000
  Marketing expenses as a percentage of total sales: ($300,000 / $1,500,000) * 100 = 20%

  This vertical analysis shows that marketing expenses constitute 20% of total sales, allowing Company ABC to assess whether this allocation aligns with industry standards and business objectives.

  By combining these analyses, Company ABC gains a comprehensive understanding of its financial trends and expense structures, enabling more informed strategic decisions.