Methods of Economic Analysis : Positive & Normative Reasoning

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Meaning of Economic Analysis

Economic analysis is both theoretical and empirical. Both theoretical and empirical analyses use three types of languages which are verbal, statistical and mathematical.

Methods of Economic Analysis
Methods of Economic Analysis

Economic analysis can be divided into positive economics and normative economics. Positive economics is concerned with what is. It analyses the functioning of an economic system and highlights the econimic problems to be solved.

Normative economics deals with what ought to be and how economic problems should be solved. Value judgements are made here.

The two approaches are predicated on the deductive and inductive methods of reasoning. The deductive method starts with basic assumptions / observations leading to logical conclusions of a general nature.

The inductive method, on the other hand. starts from the specific to the general. Both methods are constantly used in economics.

Microeconomics is the part of economics concerned with the detailed workings of the economy, that is, the study of particular cases such as the supply of rice, unemployment in the banking industry, the best output of a firm for a particular commodity, etc.

Financial Economic Analysis Methods

The financial economic analysis methods are considered as the procedures used to simplify, separate or reduce the descriptive and numerical data that make up the financial statements, in order to measure the relationships in a single period and the changes presented in several accounting years.

A good measure of analysis is to compare the results obtained in a period with the results obtained in previous periods and with the budgeted figures. Comparisons can be made as follows:

  • Figures for the current month, compared to the budget for the month.
  • Accumulated current year figures, compared with the accumulated budget.
  • Cumulative figures for the fiscal year, compared with the same data from the previous year.

The analysis methods are classified as:

  • Vertical analysis method:

o Procedure of integral hundreds.

o Procedure of simple reasons.

  • Horizontal analysis method:

o Procedure for increases and decreases.

  • Historical analysis method: It analyzes trends, whether of percentages, indices or financial ratios.

Some significant aspects of the horizontal and vertical analysis will be discussed below.

Horizontal or Increase and Decrease Analysis

In the horizontal method, the last two periods are compared with each other, since in the current period the accounting is compared against the budget.

The application of this method is based on the technique of increases and decreases based on the comparison of the items of a financial statement between two given dates in order to know if there was an increase or a decrease between both and to what extent.

Variations between both dates will be calculated as follows:

  1. Increase and decrease in absolute values.
  2. Increase and decrease in relative values.

To demonstrate the application of this technique, for example, the income statement for the current year is compared with the base year and the current year with respect to the plan.

  1. The calculation of the variations in absolute values ​​is obtained by means of the difference between the amount of the current year and the base year.
  2. The calculation of the variations in relative values ​​is determined by dividing the variation between both years (current – base) by the amount of the base year and this result is multiplied by 100.

Vertical or Component Analysis

By this technique, the composition of total assets, current assets and liabilities, liabilities and capital and stockholders’ equity can be analyzed, determining the specific weight of each item of the income statement in relation to sales.

The method is used to analyze financial statements such as the balance sheet and the income statement, comparing the figures vertically. It refers to the use of the financial statements of a period to know its situation or results.

For this, it is necessary to convert the financial statements to analytical percentages, that is, integral percentages of the asset concepts considering this equal to 100 and integral percentages of the liability and capital concepts considering these equal to 100. In the same way,

In the vertical analysis, it will be possible to observe which are the most important accounts of each of the financial statements and the percentage that they represent in relation to the comparison figure and in the income statement, the profit margin on sales obtained in the period can be determined , the percentages represent the equivalent of each figure that composes it, compared to the sales category.

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