Analyzing Financial Statements is a critical skill for understanding a company’s financial health and performance. Among the many techniques available, horizontal analysis and vertical analysis are two of the most widely used. Each method provides unique insights, helping managers, investors, and business owners make informed decisions.
This article explains horizontal and vertical analysis, their differences, and how they are applied in financial statement analysis.
What Is Horizontal Analysis?
Horizontal analysis, also known as trend analysis, evaluates financial statement data over multiple periods to identify growth patterns, trends, and fluctuations. It focuses on changes in amounts and percentages from one period to the next.
Key Features:
- Compares financial performance across two or more periods
- Expresses changes in absolute terms and as percentages
- Helps detect trends, growth rates, or irregularities
Example:
If a company’s revenue was $100,000 last year and $120,000 this year, horizontal analysis calculates:
- Absolute change = $120,000 – $100,000 = $20,000
- Percentage change = ($20,000 ÷ $100,000) × 100 = 20%
This method helps analyze whether revenues, expenses, or profits are increasing, decreasing, or remaining stable over time.
What Is Vertical Analysis?
Vertical analysis, also called common-size analysis, evaluates each item in a financial statement as a percentage of a base amount, providing a snapshot of the relative size of components within a single period.
Key Features:
- Expresses each line item as a percentage of total revenue (for income statements) or total assets (for balance sheets)
- Helps identify cost structures, expense ratios, and profitability proportions
- Useful for comparing companies of different sizes or analyzing a single company’s structure over time
Example:
If total revenue is $200,000 and the cost of goods sold (COGS) is $80,000:
- COGS as a percentage of revenue = ($80,000 ÷ $200,000) × 100 = 40%
Vertical analysis shows how each component contributes to the overall financial picture, making it easier to spot areas of concern, such as high operating costs or low profit margins.
Horizontal vs Vertical Analysis: Key Differences
| Aspect | Horizontal Analysis | Vertical Analysis |
| Focus | Changes over multiple periods | Relative proportions within a single period |
| Purpose | Identify trends, growth, or decline | Understand composition of financial statements |
| Measurement | Absolute and percentage changes | Percentage of total revenue or total assets |
| Best Use | Long-term performance evaluation | Cost structure analysis and comparability |
| Example | Revenue growth of 10% year-over-year | COGS represents 40% of total revenue |
Both analyses complement each other: horizontal analysis identifies trends, while vertical analysis provides context for each item’s significance.
Practical Applications
1. For Business Owners and Managers
- Horizontal analysis: Evaluate revenue growth, expense trends, and profitability changes over time.
- Vertical analysis: Assess expense composition, cost efficiency, and profit margins relative to total sales.
2. For Investors
- Horizontal analysis: Identify companies with consistent growth and stable financial performance.
- Vertical analysis: Compare profitability and expense structures across companies, regardless of size.
3. For Lenders
- Horizontal analysis: Track financial stability and growth trends to assess repayment capacity.
- Vertical analysis: Evaluate the proportion of debt relative to assets to understand leverage.
Steps to Conduct Horizontal and Vertical Analysis
Horizontal Analysis:
- Select periods for comparison (e.g., current year vs previous year)
- Calculate absolute changes for each line item
- Compute percentage changes to assess growth or decline
- Interpret trends and identify significant fluctuations
Vertical Analysis:
- Choose a base amount (total revenue for income statement, total assets for balance sheet)
- Express each item as a percentage of the base
- Compare with previous periods or industry benchmarks
- Identify areas of strength or concern
Benefits of Combining Both Methods
Using horizontal and vertical analysis together provides a comprehensive view of financial performance:
- Horizontal analysis reveals trends over time
- Vertical analysis shows structural composition
- Together, they highlight both growth opportunities and areas needing cost control
For example, a company may show rising revenue (horizontal analysis), but vertical analysis may reveal increasing expenses as a percentage of sales, signaling potential profit erosion.
Conclusion
Horizontal and vertical analysis are essential techniques in A superior way to conduct business due diligence. Horizontal analysis focuses on trends and changes over time, while vertical analysis emphasizes the proportion of each financial statement component within a single period.
By combining both methods, business owners, investors, and managers can gain deeper insights into financial performance, identify risks, evaluate growth opportunities, and make informed strategic decisions. Mastering these analyses ensures a more accurate, actionable understanding of a company’s financial health.