Learn all about horizontal and vertical analysis methods in just a few minutes! Fabio Ambrosio, CPA, instructor of accounting at the Central Washington University, explains horizontal analysis, which helps identify trends over time, and vertical analysis, which is useful in comparing performance between entities.
Horizontal and vertical analysis are two tools commonly used to assess organizational performance. Horizontal analysis helps identify trends over time. Vertical analysis is useful in comparing performance between entities.
Horizontal analysis and vertical analysis are two of the three primary methods used to analyze financial statements. Commonly referred to as trend, or time series, analysis, horizontal analysis compares changes from period to period, expressing each line as a percentage of another line, using comparative financial statements. Horizontal analysis is optimal when comparing previous years' financial results. The change in line items can be expressed in dollars or as a percentage. To express the change as a dollar amount, subtract the amount of the item in the base period from the amount of the item in the current period. To express the change as a percentage, take the dollar amount change and divide it by the amount of the item in the base period. For example, Charlie’s Camper Company had current assets in 2016 of $433,000, and in 2017 they were $525,000. The change in dollar value from one year to the next is $92,000. This change can also be expressed as a percentage by dividing $92,000 by $433,000. The percentage change from 2016 to 2017 is 21%.
Vertical analysis is an analysis method that depicts the relationship that exists among each line of a financial statement using a base amount in the same period. Vertical analysis is used to compute percentages, which allows users to evaluate a business entity's performance and provide comparison among competitors. Reporting each line item of the financial statement as a percentage makes it easier to compare previous performance and performance between organizations. Vertical analysis is also known as common-size analysis because relevant comparisons can be made between companies of varying sizes. To complete vertical analysis, each item on the financial statement is presented as a percentage of a base amount. On the income statement, sales is the base amount. On the balance sheet, total assets is used as the base amount. The statement of cash flows expresses all line items as a percentage of total cash flow. For example, in 2017 Charlie’s Camper Company has current assets of $525,000 and total assets of $1,014,500. To complete vertical analysis and convert current assets to a percentage, divide current assets of $525,000 by total assets of $1,014,500. Current assets represent 52% of the total assets.