What are Horizontal Analysis and Vertical Analysis? Give Example.

Horizontal analysis and vertical analysis are both financial analysis techniques used to assess the performance and financial health of a company. They involve examining financial statements such as the income statement, balance sheet, and cash flow statement.

  1. Horizontal Analysis:

Horizontal analysis, also known as trend analysis, involves comparing financial data across different periods. The purpose is to identify trends or changes over time, usually by expressing the data as a percentage increase or decrease from a base year. This analysis helps in understanding the direction and magnitude of changes in financial performance or position.

Example of Horizontal Analysis:

Let’s say we have the following income statement for Company XYZ for the past three years:

Income Statement (in $ thousands)

Year 3 Year 2 Year 1

Revenue $500 $450 $400

Expenses $350 $320 $300

Net Income $150 $130 $100

To conduct horizontal analysis, we calculate the percentage change for each item compared to the previous year. For instance:

  • Percentage Change in Revenue Year 3 compared to Year 2: (500 – 450) / 450 * 100 = 11.11%
  • Percentage Change in Expenses Year 3 compared to Year 2: (350 – 320) / 320 * 100 = 9.375%
  • Percentage Change in Net Income Year 3 compared to Year 2: (150 – 130) / 130 * 100 = 15.38%

This analysis helps to identify how revenue, expenses, and net income have changed over the years and assess the company’s overall performance trends.

  1. Vertical Analysis:

Vertical analysis, also known as common-size analysis, involves expressing each line item of a financial statement as a percentage of a base item within the same period. The base item is typically total revenue for the income statement and total assets for the balance sheet. Vertical analysis helps to assess the relative proportions of different items within a financial statement and identify potential areas of concern or efficiency.

Example of Vertical Analysis:

Using the same income statement for Company XYZ:

rubyCopy code

Income Statement (in $ thousands)

Year 3 Year 2 Year 1

Revenue $500 $450 $400

Expenses $350 $320 $300

Net Income $150 $130 $100

To conduct vertical analysis, we express each item as a percentage of total revenue for each year. For instance:

  • Vertical Analysis of Revenue for Year 3: ($500 / $500) * 100 = 100%
  • Vertical Analysis of Expenses for Year 3: ($350 / $500) * 100 = 70%
  • Vertical Analysis of Net Income for Year 3: ($150 / $500) * 100 = 30%

This analysis helps in understanding the composition of the income statement and the relative proportion of expenses to revenue, enabling comparison across different periods and with industry benchmarks.

Leave a Comment