However, investors should combine horizontal analysis with vertical analysis and other techniques to get a true picture of a company’s financial health and trajectory. Looks at the proportional representation of each line item on financial statements by expressing them as a percentage of total sales. Horizontal analysis, or “time series analysis”, is oriented around identifying trends and patterns in the revenue growth profile, profit margins, and/or cyclicality (or seasonality) over a predetermined period. For a horizontal analysis, you compare like accounts to each other over periods of time — for example, accounts receivable (A/R) in 2014 to A/R in 2015. It helps identifying growth trends as well as can indicate how efficiently the business is managing its expenses over the years.
- The highlighted part of the figure shows the number used as the base to create the common-sizing.
- Vertical analysis expresses each amount on a financial statement as a percentage of another amount.
- This analysis gives the company a heads up if cost of goods sold or any other expense appears to be too high when compared to sales.
- Also known as trend analysis, this method is used to analyze financial trends that occur across multiple accounting periods over time—usually by the quarter or year.
- As with the horizontal analysis, you need to use more years for any meaningful trend analysis.
Differences Between Horizontal and Vertical Analysis
- It helps to assess the growth or decline of specific line items such as revenue, expenses, or net income.
- Depending on their expectations, Mistborn Trading could make decisions to alter operations to produce expected outcomes.
- The more periods you have to compare, the more robust your data set will be, and the more useful the insights gathered.
- It involves identifying the co-relation of items relating to a company’s financial information and how they affect the overall performance of an organization.
- Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs.
If analysis reveals any unexpected differences in income statement accounts, management and accounting staff at the company should isolate the reasons and take action to fix the problem(s). Vertical analysis expresses each line item on a company’s financial statements as a percentage of a base figure, whereas horizontal analysis is more about measuring the percentage change over a specified period. One of the pros of vertical analysis is that it allows for the comparison of financial statements from one accounting period to the next as well as for comparisons among different companies. One of its cons is that it doesn’t take into consideration absolute numbers; so if you are comparing two companies, looking at percentages will give a different result than absolute numbers.
Horizontal Analysis on Income Statement Example
The same dollar change and percentage change calculations would be used for the income statement line items as well as the balance sheet law firm chart of accounts line items. The figure below shows the complete horizontal analysis of the income statement and balance sheet for Mistborn Trading. Horizontal analysis is used in financial statement analysis to compare historical data, such as ratios, or line items, over a number of accounting periods. Horizontal analysis can either use absolute comparisons or percentage comparisons, where the numbers in each succeeding period are expressed as a percentage of the amount in the baseline year, with the baseline amount being listed as 100%. Vertical analysis is a useful tool for financial statement analysis and helps businesses gain insight into their financial position and performance.
Example of Vertical Analysis of a Balance Sheet
On the other hand, vertical analysis refers to the horizontal and vertical analysis analysis of financial data independent of time and the co-relation of items relating to a company’s financial information and how they affect the overall performance of an organization. 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 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.
- Companies use horizontal analysis to spot trends and growth patterns in their financial statements.
- The primary aim of horizontal analysis is to compare line items in order to ascertain the changes in trend over time.
- By calculating the difference and converting to percentages, we can quickly create a thumbnail snapshot of revenue growth or contraction.
- In Horizontal Financial Analysis, the comparison is made between an item of financial statement, with that of the base year’s corresponding item.
- It’s often used when analyzing the income statement, balance sheet, and cash flow statement.
Step 1: Gather Financial Information
He is a four-time Dummies book author, a blogger, and a video host on accounting and finance topics. Further analysis via horizontal analysis will likely be required to unlock those insights, and make use of them in a strategic way. Another similarity to horizontal analysis is vertical analysis’ utility during external as well as internal analysis. The more periods you have to compare, the more robust your data set will be, and the more useful the insights gathered. This method is particularly useful for both internal analysis to identify areas of growth and external analysis by investors or lenders who want to see demonstrable growth before contribution margin committing their resources to your business. After squaring the differences and adding them up, then dividing by the total number of items, we find that the variance is $5,633,400.
