What is horizontal and vertical analysis?

Learn about the various types of financial analysis.

There are various types of financial analysis:

• Vertical analysis
• Horizontal analysis
• Leverage analysis
• Ratio analysis (which includes liquidity analysis, profitability analysis, etc)
• Sensitivity analysis
• What-if analysis.

Each analysis has its own place and importance in financial analysis; however, the ones we will focus on are vertical analysis (most commonly used), horizontal analysis, ratio analysis and sensitivity analysis.

Before we dive into each of these, we need to review the different components of a financial statement in order to assist us with a financial statement analysis.

It is important to note that the following analysis focuses on financial statements; however, financial analysis has a broader focus and internally there are various different financial metrics that organisations, depending on their focus and departments, may have on hand.

After watching the video in the previous step, you should now have a basic understanding of the components of a financial report by an organisation. Let’s look at how we might perform a horizontal analysis.

• Horizontal analysis is one of the most commonly performed financial analysis techniques, and it allows us to evaluate trends across two chosen periods (e.g. year-on-year, quarter-over-quarter, etc.).
• The purpose of this is to be able to understand the past and use it as insight into what the company might do in the future.
• It is important to note that you should only compare like for like line items, for example, cost of sales 2020 vs cost of sales 2019.

See below an example from the Woolworths Annual Report 2019:

The formula for the horizontal analysis is:

• % Change = ((Amount in Comparison Year − Amount in Base Year) / (Amount in Base Year)) x 100
  • If you don’t want a percentage, you simply omit the final step (multiply by 100)

Vertical Analysis

Another common type of financial analysis is vertical analysis. Rather than looking horizontally across the financial statement, you analyse it vertically.

You would most commonly use vertical analysis on an income statement and would use it to show expense line items as a percentage of sales. Thus, you would look at each line item on the income statement and divide it by gross sales to see the percentage of each item as gross sales. You could do the same exercise on the balance sheet, except it would show as a percentage of total assets or similarly as total liabilities.

Unlike horizontal analysis, vertical analysis does not compare the two periods directly (eg, Y1–Y2), instead, it breaks down each period separately, allowing you to compare changes in percentages and try to determine why they may have changed. It allows you to see the correlation between single items and the bottom line. It is also extremely effective when comparing companies that might be of different sizes but in the same industry, as it lets you analyse operational differences at the same base.

(Source: Woolworths Annual Report 2019, pg 68) [1]

References

1. Woolworths Group Limited. 2019 Annual Report [Internet]. Available from: https://www.woolworthsgroup.com.au/icms_docs/195582_annual-report-2019.pdf

Financial statements such as the income statement, balance sheet, and cash flow statement are important statements that should be studied extensively in order to arrive at conclusions regarding the performance of the current financial year as well as to assist planning the upcoming financial year’s budget. Horizontal and vertical analysis are two main types of analysis methods used for this purpose. The key difference between horizontal and vertical analysis is that horizontal analysis is a procedure in financial analysis in which the amounts in financial statements over a certain period of time is compared line by line in order to make related decisions whereas vertical analysis is the method of analysis of financial statements where each line item is listed as a percentage of another item.

CONTENTS
1. Overview and Key Difference
2. What is Horizontal Analysis
3. What is Vertical Analysis
4. Side by Side Comparison – Horizontal vs Vertical Analysis
5. Summary

What is Horizontal Analysis?

A horizontal analysis, also referred to as ‘trend analysis’, is a procedure in the financial analysis where the amounts of financial information over a certain period of time is compared line by line in order to make related decisions.

E.g. HGY Company’s income statement for the year ended 2016 is shown below along with the financial results for the year 2015.

Horizontal analysis involves comparing financial results line by line horizontally. This assists understanding how the results have changed from one financial period to another. This can be calculated in absolute terms as well as in percentage terms. In the above example, revenue of HGY has increased by $1,254m ($6,854m- $5,600m). As a percentage, this increase amounts to 22.4% ($1,254m/$5,600m* 100).

It is important for every company to grow their business over time in order to create shareholder value. Thus, horizontal analysis helps to understand how successfully this has been achieved considering a period of time.

What is Vertical Analysis?

Vertical analysis is the method of analysis of financial statements where each line item is listed as a percentage of another item to conduct useful decision making. Here, each line item on the income statement is expressed as a percentage of sales revenue and each line item on the balance sheet is expressed as a percentage of total assets. Continuing from the above example,

E.g. HGY’s gross profit margin for 2015 and 2016 is $3,148m can be calculated as,

Gross profit margin for 2015 = $3,148m/$5,600m* 100
= 56.2%

Gross profit margin for 2016 = $3,844m/$6,854m* 100
= 56.1%

The comparison between the two ratios indicates that despite the rise in both revenue and cost of sales, the gross profit has changed only marginally.

Financial statements should be prepared in a standard vertical format in accordance with accounting standards. The main use of vertical analysis is to calculate the financial ratios which in turn are key metrics in evaluating company performance. Once the ratios are calculated, they can be easily compared with ratios in similar companies for benchmarking purpose.

Figure 01: Horizontal analysis and vertical analysis is conducted using the same financial statements

What is the difference between Horizontal and Vertical Analysis?

Summary- Horizontal vs Vertical Analysis

The key difference between horizontal and vertical analysis depends on the way financial information in statements are extracted for decision making. Horizontal analysis compares financial information over time by adopting a line by line method. Vertical analysis is focused on conducting comparisons of ratios calculated using financial information. Both these methods are conducted using the same financial statements and both are equally important to make decisions that affect the company on an informed basis.

References 1.”Horizontal Analysis.” Investopedia. N.p., 12 Aug. 2015. Web. 12 Apr. 2017. 2.”Vertical Analysis.” Investopedia. N.p., 17 July 2015. Web. 12 Apr. 2017.

3.”Horizontal Vs Vertical Analysis of Financial Statements.” Accounting, Financial, Tax. N.p., n.d. Web. 13 Apr. 2017.