Horizontal And Vertical Analysis In Financial Statement Analysis: Concepts, Methods, And Comparison

 Analysing financial statements is key to assessing the performance of a business. One such analysis is horizontal analysis and vertical analysis. Both methods seek to give an indication of how a business is performing, but from different angles - one over a period of time, and the other in the same period.

Knowing how they work can help financial analysts, students and entrepreneurs to better understand financial information and make informed decisions.

Horizontal Analysis Explained In Financial Statement Analysis

Horizontal analysis is a technique for analysing financial statements over time. This type of analysis is used to look for trends in data like revenue, expenses, profits and so on, across multiple years.

This approach can be used to answer questions such as: Is it spending more than it's earning? Horizontal analysis shows how these changes have occurred over time and trends in performance and direction.

What Is Vertical Analysis And How It Works In Accounting

Vertical analysis is a method to present items of a financial statement as a percentage of a base amount. In the income statement, the base figure is revenue and for the balance sheet, it is total assets.

This technique can be used to analyse the composition of financial statements. It helps understand the contribution of each element in the performance of the business, and is useful in evaluating the cost structure and the financial structure.

Horizontal And Vertical Analysis Comparison In Finance

The key differences between horizontal and vertical analysis are the types of information they convey. Horizontal analysis is concerned with changes from period to period, whereas vertical analysis is concerned with percentages in a period.

Horizontal analysis helps to detect trends and growth, while vertical analysis helps to detect cost behaviour and inter-relationships. Both analyses are used to gain a better understanding of financial performance.

Vertical Analysis Of Financial Statements With Examples

An example of vertical analysis is to examine the relationship between expenses and revenue. If a substantial part of revenue is being used up by operating costs, it could be a sign of inefficiency.

Similarly, in the balance sheet, examining the financing of assets (debt/equity) gives an indication of financial risk. It's based on the relative values, not absolute values.

How To Perform Horizontal Analysis Step By Step

To conduct horizontal analysis, choose financial information for different periods. Select a base period and compare other periods to this base.

Then, determine the variations in each financial element and analyse trends. Look for trends in the form of steady increases, decreases or erratic movements.

Vertical Analysis Method For Income Statement And Balance Sheet

The vertical analysis method for income statement is where each item is presented as a percentage of total revenue. This shows the relationship between revenue, expenses and profits.

For the balance sheet, percentage of total assets is used. This allows us to understand how resources are used and how it is funded.

Conclusion

Horizontal and vertical analysis are valuable techniques to analyze financial performance. Horizontal analysis provides insights into trends, and vertical analysis into the composition of statements. Combining both approaches allows companies and investors to better understand and interpret financial statements and improve financial decision making.