Key Difference – Horizontal vs Vertical Analysis
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?
Horizontal vs Vertical Analysis |
|
| Horizontal analysis is a procedure in the fundamental analysis in which the amounts of financial information over a certain period of time is compared line by line in order to make related decisions. | Vertical analysis is the method of analysis of financial statements where each line item is listed as a percentage of another item to assist decision making. |
| Main Purpose | |
| The main purpose of horizontal analysis is to compare line items to calculate the changes over time. | Main purpose of vertical analysis is to compare changes in percentage terms. |
| Usefulness | |
| Horizontal analysis becomes more useful when comparing company results with previous financial years. | Vertical analysis is more useful in comparing company results with other companies. |
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.
Image Courtesy:
1. “y2cary3n6mng-5ha51l-income-statement-example” by Peter Baskerville (CC BY-SA 2.0) via Flickr