Horizontal analysis can be performed by comparing a recent year against the base year while identifying the growth trends between the time periods. The analysis can be performed in any four types of financial statement i.e. income statement, balance sheet, statement of cash flow, and statement of changes in equity. However, income statement and balance sheet are mostly used financial statement to do horizontal analysis (Lubatkin, 1983). And, that is what we’re going to base the post on.
To do horizontal analysis, these are the steps that one needs to follow through:
Calculate for the comparing year index. This is done by doing comparing year/base year.
Once the index is calculated for the comparing year, multiply the result by 100 and then subtract it by the base year index.
Once the result is out showing either the increase of decrease, find out why the result is so. This need to be done even when the result is positive.
Horizontal analysis is used by companies to see what has been the factors to drive the company’s financial performance over a number of years (Aizenman & Marion, 2004). With the use of this analysis, companies can also identify growth pattern and spot trends like during hurricane in the United States, the demand of water bottles is higher so Walmart stocks more of it as per the prediction that hurricane is going to occur. (Miller & Goidel, 2009) Like in Nepal as well, the demand/sell of clothes and other appliances is higher during special festivals or occasions compared to other normal days. It allows the company to have a detailed look at each of the line item. They can even have a complete picture of an operational result by analyzing financial statement, balance sheet, and cash flow statement at the same time. With it, the company can assess its profitability and operational efficiency while also looking at what has been driving the company’s performance.
Let’s look at an example of horizontal analysis using balance sheet first. It includes three main components i.e. assets, liabilities and equity. An example of a company’s asset can be a building; liability can be a loan on the building, and equity can be the total investment in the company. Let’s look at the assets of a sample company to look at the horizontal analysis of the same:
As in the table, year 1 is considered to be base and its index value is thus taken to be 100. For Year 2 to calculate the index value we divide the dollar value of it with the dollar value in year 1 and multiply it by 100, which is as below:
(15000/10000) * 100 = 1.5 * 100 = 150
Now, to compare the index value between two years, it’s 150 - 100 = 50. Through this, we can say that the assets increased from year 1 to year 2 by 50%. The company should look into why it rose by 50% for this discussion with the accounting department can be scheduled to know what assets were purchased in year 2 to give it a significant rise.
Taking another example using the income statement of whose sales revenue is taken into account. This helps in calculating the profit/loss from the overall operation. The calculation is as follows:
Year 1 sales revenue is considered to be base and thus has its index value as 100. For year 2, to calculate the index value, we follow the same procedure as done above:
(8000/10000) * 100 = 0.8 * 100 = 80
Now, to compare the index value of year 2 and 1, we get 80 - 100 = -20. We can see that sales revenue actually took a dive in year 2. We need to determine why for this as well and thus look into what made it happen. Like did the competitors had extensive marketing campaigns? Was the advertisement sent out by the company not effective/enough? And other questions to get to the root of it.
Vertical analysis is when different aspects of the financial statement are compared in terms of percentage of the total amount (Amihud & Lev, 1981). An example of this can be when you bought a car for say $50,000 and started comparing how much you paid for different parts of the car. You figured that the engine cost $5,000, you can say that it cost you 10% of the total amount. This type of analysis is called as vertical analysis. Like horizontal analysis, it is also compared usually on the income statement and balance sheet. We’re often looking at the percentage for this analysis. With this analysis, we can see where the money is going and if it’s time to make an investment on a new technology, find an alternative supplier, reallocate cash or make the adjustment to inventory.
To do vertical analysis, these are the steps that one needs to follow through:
For the balance sheet, the items of the sheet are divided by total assets. After which they’re multiplied by 100 to get a percentage value.
For the income statement, the items of the statement are divided by revenue. After which they’re multiplied by 100 to get a percentage value.
Perform analysis on the result regardless of it showing a positive or negative outcome on why that happened.
With vertical analysis, one can see the relative proportions of account balance. This simplifies the process of comparing the financial statement of the company against another or to even do it across the industry. This analysis also gives a better picture of the performance metrics of the company and if it’s improving or on a decline. That is done by looking at the annual or quarterly figures of the company and comparing it over a number of years.
An example of vertical analysis considering the balance sheet (simplified version for demonstration) is as below:
In the above table, following calculations are made and populated:
Percentage change for Cash for 2017 = (6500/86000)*100 = 7.56%
Percentage change for Cash for 2016 = (5000/76500)*100 = 6.54%
Percentage change for Prepaid Expenses for 2017 = (3000/86000)*100 = 3.49%
Percentage change for Prepaid Expenses for 2016 = (2500/76500)*100 = 3.27%
From the analysis, we can make out that both cash and prepaid expenses increased in 2017 compared to 2016.
Similarly, looking at another example with select parameters taken into account from the financial statement is as below:
The value in the above table is populated after the following calculation where the percentage change is computed by dividing the item (cost of sales) by revenue as this:
Percentage of Cost of Sales for 2017 = (1800/4800)*100 = 37.5%
Percentage of Cost of Sales for 2016 = (1500/4500)*100 = 33.33%
The calculated percentage value is used in the table above. The following analysis shows that the portion of the cost of sales has increased by over 4% comparing the records of 2017 and 2016.
References
Aizenman, J., & Marion, N. (2004). The merits of horizontal versus vertical FDI in the presence of uncertainty. Journal Of International Economics , 62 (1), 125-148.
Amihud, Y., & Lev, B. (1981). Risk Reduction as a Managerial Motive for Conglomerate Mergers. The Bell Journal Of Economics , 12 (2), 605.
Lubatkin, M. (1983). Mergers and the Performance of the Acquiring Firm. Academy Of Management Review , 8 (2), 218-225.
Miller, A., & Goidel, R. (2009). News Organizations and Information Gathering During a Natural Disaster: Lessons from Hurricane Katrina. Journal Of Contingencies And Crisis Management , 17 (4), 266-273.
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Horizontal analysis can be performed by comparing a recent year against the base year while identifying the growth trends between the time periods. The analysis can be performed in any four types of financial statement i.e. income statement, balance sheet, statement of cash flow, and statement of changes in equity. However, income statement and balance sheet are mostly used financial statement to do horizontal analysis (Lubatkin, 1983). And, that is what we’re going to base the post on.
To do horizontal analysis, these are the steps that one needs to follow through:
Horizontal analysis is used by companies to see what has been the factors to drive the company’s financial performance over a number of years (Aizenman & Marion, 2004). With the use of this analysis, companies can also identify growth pattern and spot trends like during hurricane in the United States, the demand of water bottles is higher so Walmart stocks more of it as per the prediction that hurricane is going to occur. (Miller & Goidel, 2009) Like in Nepal as well, the demand/sell of clothes and other appliances is higher during special festivals or occasions compared to other normal days. It allows the company to have a detailed look at each of the line item. They can even have a complete picture of an operational result by analyzing financial statement, balance sheet, and cash flow statement at the same time. With it, the company can assess its profitability and operational efficiency while also looking at what has been driving the company’s performance.
Let’s look at an example of horizontal analysis using balance sheet first. It includes three main components i.e. assets, liabilities and equity. An example of a company’s asset can be a building; liability can be a loan on the building, and equity can be the total investment in the company. Let’s look at the assets of a sample company to look at the horizontal analysis of the same:
As in the table, year 1 is considered to be base and its index value is thus taken to be 100. For Year 2 to calculate the index value we divide the dollar value of it with the dollar value in year 1 and multiply it by 100, which is as below:
Now, to compare the index value between two years, it’s 150 - 100 = 50. Through this, we can say that the assets increased from year 1 to year 2 by 50%. The company should look into why it rose by 50% for this discussion with the accounting department can be scheduled to know what assets were purchased in year 2 to give it a significant rise.
Taking another example using the income statement of whose sales revenue is taken into account. This helps in calculating the profit/loss from the overall operation. The calculation is as follows:
Year 1 sales revenue is considered to be base and thus has its index value as 100. For year 2, to calculate the index value, we follow the same procedure as done above:
Now, to compare the index value of year 2 and 1, we get 80 - 100 = -20. We can see that sales revenue actually took a dive in year 2. We need to determine why for this as well and thus look into what made it happen. Like did the competitors had extensive marketing campaigns? Was the advertisement sent out by the company not effective/enough? And other questions to get to the root of it.
Vertical analysis is when different aspects of the financial statement are compared in terms of percentage of the total amount (Amihud & Lev, 1981). An example of this can be when you bought a car for say $50,000 and started comparing how much you paid for different parts of the car. You figured that the engine cost $5,000, you can say that it cost you 10% of the total amount. This type of analysis is called as vertical analysis. Like horizontal analysis, it is also compared usually on the income statement and balance sheet. We’re often looking at the percentage for this analysis. With this analysis, we can see where the money is going and if it’s time to make an investment on a new technology, find an alternative supplier, reallocate cash or make the adjustment to inventory.
To do vertical analysis, these are the steps that one needs to follow through:
For the balance sheet, the items of the sheet are divided by total assets. After which they’re multiplied by 100 to get a percentage value.
For the income statement, the items of the statement are divided by revenue. After which they’re multiplied by 100 to get a percentage value.
Perform analysis on the result regardless of it showing a positive or negative outcome on why that happened.
With vertical analysis, one can see the relative proportions of account balance. This simplifies the process of comparing the financial statement of the company against another or to even do it across the industry. This analysis also gives a better picture of the performance metrics of the company and if it’s improving or on a decline. That is done by looking at the annual or quarterly figures of the company and comparing it over a number of years.
An example of vertical analysis considering the balance sheet (simplified version for demonstration) is as below:
In the above table, following calculations are made and populated:
From the analysis, we can make out that both cash and prepaid expenses increased in 2017 compared to 2016.
Similarly, looking at another example with select parameters taken into account from the financial statement is as below:
The value in the above table is populated after the following calculation where the percentage change is computed by dividing the item (cost of sales) by revenue as this:
The calculated percentage value is used in the table above. The following analysis shows that the portion of the cost of sales has increased by over 4% comparing the records of 2017 and 2016.
References
Aizenman, J., & Marion, N. (2004). The merits of horizontal versus vertical FDI in the presence of uncertainty. Journal Of International Economics , 62 (1), 125-148.
Amihud, Y., & Lev, B. (1981). Risk Reduction as a Managerial Motive for Conglomerate Mergers. The Bell Journal Of Economics , 12 (2), 605.
Lubatkin, M. (1983). Mergers and the Performance of the Acquiring Firm. Academy Of Management Review , 8 (2), 218-225.
Miller, A., & Goidel, R. (2009). News Organizations and Information Gathering During a Natural Disaster: Lessons from Hurricane Katrina. Journal Of Contingencies And Crisis Management , 17 (4), 266-273.