Horizontal analysis, also known as trend analysis, compares historical data on a financial statement over different accounting periods. There is a baseline period and numbers from succeeding periods are calculated as a percentage of the base period. Vertical analysis looks at numbers in financial statements in the same period and calculates each line item as a percentage of the base figure in that section. Financial statements that include vertical analysis clearly show line item percentages in a separate column. In order to use the vertical analysis equation, you need to figure out your base figure.
Vertical Analysis vs. Horizontal Analysis
It is one of the popular methods of financial statements as it vertical analysis is also known as is simple and also called a common size analysis. The technique can be used to analyze the three primary financial statements, i.e., balance sheet, income statement, and cash flow statement. In the balance sheet, the common base item to which other line items are expressed is total assets, while in the income statement, it is total revenues.
Vertical analysis, also known as common-size analysis, is a technique used to assess the relative proportions of different line items within a financial statement. This allows for meaningful comparisons and identification of trends over time or across companies. The balance sheet provides a snapshot of a company’s financial position at a specific point in time. The balance sheet helps evaluate the company’s liquidity, solvency, and overall financial health. In this vertical analysis, we express each item on the balance sheet as a percentage of the total assets (for assets) or total liabilities and equity (for liabilities and equity). This helps us understand the composition of the balance sheet and identify any significant trends or deviations.
Look for items with a significant percentage of Total Assets, as these could represent areas of vulnerability or strength. Read on to learn more about vertical analysis of a balance sheet, how to perform one, and some limitations and drawbacks of this analytical tool. As you can see there is a heavy focus on financial modeling, finance, Excel, business valuation, budgeting/forecasting, PowerPoint presentations, accounting and business strategy. For example, if the value of long-term debt in relation to the total assets value is high, it may signal that the company may become distressed.
Step 5: Compare with industry benchmarks
It provides businesses with a more complex perspective of their financial well-being. It’s also important to assess the ratio of specific accounts over different time periods. With this, organizations can monitor changes and lead them to strategic decision-making.
The ratios tell investors and finance managers how the company is doing in terms of revenues, and can be used to make predictions of future revenues and expenses. Companies can also use this tool to analyze competitors to know the proportion of revenues that goes to advertising, research and development, and other essential expenses. From the table above, we calculate that cash represents 14.5% of total assets while inventory represents 12%. Common-size financial statements often incorporate comparative financial statements that include columns comparing each line item to a previously reported period. We can discern through vertical analysis that the main problem area vis-à-vis the decline in net income in year 3 is the cost of goods sold.
- This methodology allows for a meaningful comparison of line items across different periods or between companies of varying sizes.
- The balance sheet helps evaluate the company’s liquidity, solvency, and overall financial health.
- Vertical analysis provides a holistic view of a company’s financial structure, allowing us to compare apples to apples across industries.
- It can be used to compare different components of companies and the same company in different time periods.
- By comparing the percentages of line items, you can identify areas of strength or weakness and gain insights into competitive positioning.
- By highlighting the relative significance of each line item, it helps in understanding the composition of revenue, expenses, assets, and liabilities.
Deeper composition insights
It represents each line within financial statements as a proportion relative to another specified item. If the chosen base in an income statement is revenue, each line item is shown as a percentage of the revenue figure. Alternatively, the base can be net income or total gross income in the case of an income statement. So, in a vertical analysis of a balance sheet, every line item — cash, accounts receivable, fixed assets, accounts payable, stockholders equity, etc. — is shown as a percentage of total assets.
Vertical analysis is important because it helps stakeholders understand the relative proportions of accounts and performance in relation to each other. It gives business owners a more detailed view of their financial health compared to just knowing their total assets, liabilities and equity. By comparing the proportions of individual accounts from time period to period, companies can track fluctuations and use them to inform strategic decisions, assisting with financial forecasting. Vertical analysis can also be used to benchmark a company’s performance against industry averages.
