Horizontal and Vertical Analysis Methods | Principles of Accounting
What is horizontal analysis?
Financial analysts examine financial trends over time periods, particularly quarters or years, in horizontal analysis, also referred to as trend analysis or time series analysis. Financial analysts typically perform horizontal analysis prior to vertical analysis, and it is typically most beneficial for businesses that have been in operation for a long time.
With horizontal analysis, you can contrast data from one period with data from a reference period to get a broad sense of how things have changed over time. You can track how a company’s financial situation has changed, identify patterns in its data, and identify potential issues and opportunities by analyzing financial trends over time periods or years.
For instance, you could use horizontal analysis to contrast a company’s profit margins from one year to the next. Alternately, you could employ it to identify particular divisions of the business that are going through the most financial change. You could then formulate suggestions for the business to take into account based on your analysis in order to maximize its financial success.
What is financial statement analysis?
Companies use financial statement analysis as a crucial business strategy to monitor financial data, predict future trends, and make comparisons. Businesses analyze financial statements, such as income statements, cash flow statements, balance sheets, and more, to keep track of and make sense of the data contained therein. By examining these statements, a company can gain knowledge of potential issues and opportunities as well as develop financial strategies and get ready for the upcoming quarter or year. Consequently, financial analysis can significantly impact a company’s overall success.
This kind of research can assist a business in attracting investors. Financial analysis allows investors to make sense of a company’s financial data and compare one company to another. Investors frequently conduct extensive research into a company’s financial statements. They can use this information to forecast which company will likely experience financial growth and will therefore make a good investment.
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.
Examples of horizontal analysis
Here are some sample scenarios to help you understand how to use horizontal analysis:
Consider comparing a company’s current-year balance sheet to its previous-year balance sheet. Consider the previous year as your base year and assume the company had $600,000 in total assets. In comparison, the companys total assets this year are $900,000. You can see a $300,000 increase in the company’s total assets. By dividing $300,000 by $600,000, you can turn this discrepancy into a percentage of the base year, where 0 is the result. 5. From last year to this year, the total assets have increased by 50%.
A horizontal analysis of an income statement is another option. Take into account that a company’s net income from the base year, which was $400,000, increased to $500,000 this year. The difference between the two is $100,000. Divided by the amount from the base years ($400,000), the difference ($100,000) equals zero. 25. This indicates that the business’s net income rose by 25% between last year and this year.
How to perform horizontal analysis
Follow these three steps to perform a simple horizontal analysis:
What is vertical analysis?
Similar to horizontal analysis, vertical analysis, also referred to as common-size analysis, can be carried out on the same financial documents. However, rather than analyzing data horizontally across time periods, financial analysts analyze data vertically within a column. Vertical analysis converts financial statement data into percentages of a base value, which is 100%. The data may be easier to understand and visualize when expressed as percentages.
When performing a vertical analysis, the financial statement’s first line displays a base figure of 100%, and the subsequent lines each show a percentage of that base figure. For instance, the total assets or liabilities are the base figure when performing vertical analysis on a balance sheet. The base number on an income statement is net sales. Another illustration is restating each sales category as a percentage of the base value using total sales as the base value.
Employees of a company as well as outside investors can use vertical analysis. Investors can compare one company to another using vertical analysis. By allowing you to compare financial data of businesses of various sizes vertically as a percentage of a base figure, vertical analysis also makes it simple to compare businesses of various sizes.
How to perform vertical analysis
You can use these steps to perform vertical analysis:
Examples of vertical analysis
Here are some situations where using vertical analysis might be useful:
Imagine that a companys total assets are $800,000. This is the baseline value, which is 100%. The companys real estate is $400,000. If you divide $400,000 by $800,000, you get 0. 5, which equates to 50%. Real estate therefore accounts for 50% of the company’s total assets, with other assets making up the remaining 50%.
Now consider a companys income statement. Lets say that the companys net income is $500,000. In this instance, the base amount is $500,000 and has a value of 100%. The companys utility costs total $5,000. If you divide $5,000 by $500,000, you get 0. 01, which equates to 1%. As a result, utility costs for the company are expressed as 1% of the base amount. The remaining items on the income statement, such as rent payments, sales, and other expenses, can all be calculated using the same method.
Horizontal analysis vs. vertical analysis
Overall, there are a few key parallels between horizontal and vertical analysis, such as:
However, there are some additional distinctions between the two that are crucial to comprehend. The primary differences between horizontal and vertical analysis include:
What is the main difference between horizontal analysis and vertical analysis?
Given these explanations, the primary distinction between vertical analysis and horizontal analysis is that the former focuses on the connections between the numbers in a single reporting period while the latter covers several reporting periods.
What is an example of horizontal analysis?
Example of Horizontal Analysis In a horizontal analysis, changes from the baseline are typically displayed in dollars and percentages. For instance, a claim that revenues rose by 10% in the most recent quarter is based on a horizontal analysis.
Why are horizontal and vertical analysis used?
The presentational difference between horizontal and vertical balance sheets Assets and liabilities are displayed side by side in the horizontal balance sheet while they are displayed top to bottom in the vertical balance sheet.