Table of content
Introduction
Financial statement analysis is an essential tool used by investors, lenders, and stakeholders to assess a company’s financial health and performance. This process involves analyzing key financial documents such as the income statement, balance sheet, and cash flow statement. Two commonly used methods of financial statement analysis are horizontal analysis and vertical analysis.
Horizontal Analysis
Horizontal analysis examines changes in corresponding financial statement items over a period of time. This method helps identify trends such as increases or decreases in accounts and allows comparisons between different periods or different companies.
How to Perform a Horizontal Analysis
- Select a Base Year: Choose a year as the starting point for comparison.
- Calculate Percentage Change: Use the formula: Percentage Change=Current Year Amount−Base Year AmountBase Year Amount×100\text{Percentage Change} = \frac{\text{Current Year Amount} – \text{Base Year Amount}}{\text{Base Year Amount}} \times 100
- Compare with Industry Standards: If industry data is available, compare the company’s trends to its competitors.
Example: Restaurant Business
| Item | Year 2020 | Year 2021 | Difference | % Change |
|---|---|---|---|---|
| Sales | 100,000 | 120,000 | 20,000 | 20% |
| Costs | 80,000 | 90,000 | 10,000 | 12.5% |
| Gross Profit | 20,000 | 30,000 | 10,000 | 50% |
Vertical Analysis
Vertical analysis evaluates financial statement items as a percentage of a base figure. It is commonly used to compare companies in the same industry by analyzing line items relative to total sales or total assets.
How to Perform a Vertical Analysis
- Select a Base Figure: This is usually total sales (for the income statement) or total assets (for the balance sheet).
- Calculate the Percentage for Each Item: Use the formula: Percentage=Item AmountBase Figure×100\text{Percentage} = \frac{\text{Item Amount}}{\text{Base Figure}} \times 100
- Compare with Industry Averages: Evaluate how the company performs relative to industry benchmarks.
Example: Restaurant Business
| Item | Amount | % of Total |
|---|---|---|
| Sales | 120,000 | 100% |
| Costs | 90,000 | 75% |
| Gross Profit | 30,000 | 25% |
Comparison
| Aspect | Horizontal Analysis | Vertical Analysis |
|---|---|---|
| Purpose | Identifies trends over time | Compares financial components within the same period |
| Base Reference | Previous years’ figures | A specific base figure (e.g., total sales) |
| Best Used For | Tracking performance changes over time | Comparing different companies or industry standards |
| Application | Income statement, balance sheet, cash flow statement | Income statement, balance sheet |
Conclusion
Both horizontal analysis and vertical analysis are essential tools in financial statement analysis. Horizontal analysis helps assess trends over time, while vertical analysis provides insight into a company’s structure by comparing financial items as a percentage of a base figure. These methods are valuable for investors, managers, and stakeholders in evaluating financial performance and making informed decisions.
Leave a comment