Horizontal Analysis vs Vertical Analysis: What’s the Difference?

vertical vs horizontal analysis

Two of the most common, and effective, ways to do so are horizontal analysis and vertical analysis. Also referred to as trend analysis, this is the comparison of financial information such as net income or cost of goods sold between two financial quarters including quarters, months or years. Often expressed in percentages or monetary terms, it provides vertical vs horizontal analysis insights into factors that significantly affect the profitability of an organization. For instance, in the year 2015, organization A had 4 million turnover as compared to year the 2014 whereby the turnover was 2 million. The 2 million increase in turnover is a positive indication in terms of performance with a 50% increase from the year 2014.

Horizontal financial statement analysis (also referred as trend analysis) is the comparison of company’s financial report information over some periods of time. Applying horizontal analysis to firm’s statements makes it comfortable to estimate its performance over time. Vertical is the analysis of items of the company’s statements when one item is being compared to the base item. While the horizontal analysis aims to estimate the dynamics, vertical is commonly applied for a single period.

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The vertical analysis of the balance sheet will result in a common-size balance sheet. The percentages on a common-size balance sheet allow you to compare a small company’s balance sheets to that of a very large company’s balance sheet. A common-size balance sheet can also be compared to the average percentages for the industry. Horizontal analysis compares the financial data of a company over multiple periods to identify trends and changes. While vertical analysis compares different components of financial statements to the total or base amount to determine their relative proportions.

For example, earnings per share (EPS) may have been rising because the cost of goods sold (COGS) has been falling or because sales have been growing steadily. Financial professionals conduct vertical analysis to make gathering and assessment of data more manageable by using percentages to perform business analytics and comparison. Notice that the same information was used for both the horizontal and vertical analyses examples but that the results are different because of how the dollar amounts are being compared. Similar comparative statements are typically drawn out for income statement and cash flow statement as well to give a complete picture. Vertical Analysis refers to the analysis of the financial statement in which each item of the statement of a particular financial year is analysed, by comparing it with a common item. Horizontal Analysis is that type of financial statement analysis in which an item of financial statement of a particular year is analysed and interpreted after making its comparison with that of another year’s corresponding item.

Horizontal analysis vs. vertical analysis: What’s the difference?

However, the same results may be below par when the base year is changed to the same quarter for the previous year. Vertical analysis, horizontal analysis and financial ratios are part of financial statement analysis. So, for example, when analyzing an income statement, the first line item, sales, will be established as the base value (100%), and all other account balances below it will be expressed as a percentage of that number.

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7: Horizontal and Vertical Trend Analysis

Horizontal analysis can also be used to benchmark a company with competitors in the same industry. First, a direction comparison simply looks at the results from one period and comparing it to another. For example, the total company-wide revenue last quarter might have been $75 million, while the total company-wide revenue this quarter might be $85 million. This type of comparison is most often used to spot high-level, easily identifiable differences. The analysis of critical measures of business performance, such as profit margins, inventory turnover, and return on equity, can detect emerging problems and strengths.

  • Horizontal analysis typically shows the changes from the base period in dollar and percentage.
  • Financial statements that include vertical analysis clearly show line item percentages in a separate column.
  • If you purchased several fixed assets during 2018, the increase is easily explained, but if you didn’t, this would need to be researched.
  • Similarly to the common-size income statement, the cash flow statement can also be displayed in percentage of total sales.
  • Both, however, are important when it comes to business decisions based on the performance.
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As known from the basic balance sheet equation, total assets equal total liabilities plus shareholders’ equity, thus, these figures are interchangeable. Sometimes analysts also use total liabilities as a common figure, mostly when they need to estimate company’s obligations and firm’s manner of debt management. Looking at and comparing the financial performance of your business from period to period can help you spot positive trends, such as an increase in sales, as well as red flags that need https://www.bookstime.com/ to be addressed. For example, a company’s management may establish that the robust growth of revenues or the decline of the cost of goods sold as the cause for rising earnings per share. By exploring coverage ratios, interest coverage ratio, and cash flow-to-debt ratio, horizontal analysis can establish whether sufficient liquidity can service a company. Horizontal analysis can also be used to compare growth rates and profitability over a specific period across firms in the same industry.

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Regardless, accounting changes and one-off events can be used to correct such an anomaly and enhance horizontal analysis accuracy. To make the best use of your financial data, you need a robust toolkit with plenty of options for slicing and dicing information in meaningful ways. Like horizontal analysis, vertical analysis is used to mine useful insights from your financial statements.

  • Although there are many types of financial statement analysis, including variance analysis, liquidity analysis, and profitability analysis, the horizontal and vertical analyses are the two that are most frequently used.
  • For example, a business may compare sales from their current year to sales from the prior year.
  • The company will need to further examine this difference before deciding on a course of action.
  • Horizontal analysis is most useful when an entity has been established, has strong record-keeping capabilities, and has traceable bits of historical information that can be dug into for more information as needed.
  • Horizontal analysis is used to improve and enhance these constraints during financial reporting.
  • Two companies with vastly different financial profiles (e.g., a $10 million company and a $10 billion dollar international corporation) can still be meaningfully compared by reducing their financials to percentages.

If the cost of goods sold amount is $780,000 it will be presented as 78% ($780,000 divided by sales of $1,000,000). If interest expense is $50,000 it will be presented as 5% ($50,000 divided by $1,000,000). The restated amounts result in a common-size income statement, since it can be compared to the income statement of a competitor of any size or to the industry’s percentages. Vertical analysis can also be used to compare a company’s financial statements from one period to another to see how its proportions have changed over time. Horizontal analysis is a financial analysis technique used to evaluate a company’s performance over time. By comparing prior-period financial results with more current financial results, a company is better able to spot the direction of change in account balances and the magnitude in which that change has occurred.

Drawbacks of Horizontal Analysis

Net income margin, gross profit margin, operating income margin are all elements of both profitability ratio analysis and common-size analysis. For example, by showing the various expense line items in the income statement as a percentage of sales, one can see how these are contributing to profit margins and whether profitability is improving over time. It thus becomes easier to compare the profitability of a company with its peers. In horizontal analysis, the changes in specific financial statement values are expressed as a percentage and in U.S. dollars. To calculate the percentage change, first select the base year and comparison year.

The latter two tend to go hand-in-hand because the most useful benchmark against which to compare recent performance is most often the preceding period. The findings of common size analysis as compiled in the preliminary stages of due diligence are critical. The accounting period covered could be one-month, a quarter, or a full fiscal year.

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