Company Financial Statement Analysis & Interpretation of Financial Statements

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. Once you have your company’s values for the variables of interest, you need to find those of similar companies in your industry for the selected time periods. Sometimes you may find horizontal analysis reports, saving you the calculations, but you can always calculate the percentage change yourself using publicly available financial data. Remember to choose companies with similar characteristics for useful comparisons.

A common size income statement is an income statement in which each line item is expressed as a percentage of the value of sales, to make analysis easier. Vertical analysis is a method of financial statement analysis in which each line item is listed as a percentage of a base figure within the statement. For example, the vertical analysis of an income statement results in every income statement amount being restated as a percent of net sales. If a company’s net sales were $2 million, they will be presented as 100% ($2 million divided by $2 million). If the cost of goods sold amount is $1 million, it will be presented as 50% ($1 million divided by sales of $2 million).

Formula for Common Size Analysis

As against, the aim of vertical analysis is to ascertain the proportion of item, in relation to a common item in percentage terms. The horizontal analysis is helpful in comparing the results of one financial year with that of another. As opposed, the vertical analysis is used to compare the results of one company’s financial statement with that of another, of the same industry.

Now let’s discuss the differences between horizontal and vertical analysis. This analysis is done by outsiders who do not have access to the detailed internal accounting records of the business firm. These outsiders include investors, potential investors, creditors, potential creditors, government agencies, credit agencies, and the general public. Relationship between account values and revenue and highlight any trends or changes. A complete vertical statement analysis is known as a common-size financial statement. In this class, we will concentrate on liquidity, solvency, and profitability and you will learn the others in your managerial accounting class. For starters, in 2016, Apple generated $0.39 for every $1 dollar in sales it made.

Difference between the Horizontal Analysis and Vertical Analysis:

If you work in the hotel segment of the hospitality industry and especially if you are in the front office, you might have heard of the the STAR report from STR. Regardless of how useful trend analysis may be, it is regularly criticized. Horizontal analysis enables investors, analysts, and other stakeholders in the company to see how well the company is performing financially. Horizontal analysis is also known as baseline analysis, where numbers in the subsequent period are expressed as the percentage of the amount in the base year having a listed baseline of 100%. Pro forma income usually excludes items that the company thinks are unusual or nonrecurring.

• Horizontal analysis, also called time series analysis, focuses on trends and changes in numbers over time.
• A Vertical Analysis can be completed on both an Income Statement and a Balance Sheet.
• When, only a year ago in 2013, Sale Return and Allowances was only 7%, meaning that there is most likely more instances of defective items.
• In horizontal analysis, we compare the changes in the financial statements over a period of time….

Variance, which is useful in establishing positive or negative changes between periods based on comparison to the average of the squared difference from the mean for the total time measured. In this first example, I will be doing a horizontal analysis of Company A’s revenue based on its annual income statement. In the next section, you have step-by-step instructions on how to do horizontal analysis with examples using a balance sheet and an income statement. The vertical analysis of a balance sheet results in every balance sheet amount being restated as a percent of total assets. Identify and describe three common tools of financial statement analysis. See the financial statement definition, and study the purpose of financial statements. Horizontal analysis is valuable because analysts assess past performance along with the company’s current financial position or growth.

Question: Horizontal analysis:

Structured Query Language is a specialized programming language designed for interacting with a database…. Gain in-demand industry knowledge and hands-on practice that will help you stand out from the competition and become a world-class financial analyst. Make other decisions that allow management to make an informed selection on various alternatives in the conduct of its business. The content on finmasters.com is for educational and informational purposes only and should not be construed as professional financial advice. Finmasters is not a financial institution and does not provide any financial products or services. We strive to provide up-to-date information but make no warranties regarding the accuracy of our information.

After squaring the differences and adding them up, then dividing by the total number of items, we find that the variance is $5,633,400. Taking the square root of that, we get the standard deviation, which is $750,600. This method is particularly useful for both internal analysis to identify areas of growth and external analysis by investors or lenders who want to see demonstrable growth before committing their resources to your business. In this second example, I will do a horizontal analysis of Company B’s current assets based on the annual balance sheets.

Comparisons can be made both with absolute and percentage figures in the horizontal analysis. For example, comparing a company’s sales in 2018 to its sales in 2019. The following example gives the information required while preparing a horizontal analysis for an unlimited number of years. Every amount of the balance sheet item is restated as the percentage of total assets, and every item in the income statement is restated as the percentage of net sales. Also called trend analysis, is a technique for evaluating a series of financial statement data over a period of time. First, run both a comparative income statement and a balance sheet for each of the periods you want to compare. You’ll need at least two to compare, but it will easier to find trends if there are three or more.

It evaluates financial statements by expressing each line item as a percentage of the base amount for that period. The analysis helps to understand the impact of each item in the financial statement and its contribution to the resulting figure. If the two numbers are from the same statement horizontal analysis (e.g. both from the income statement and both from the balance sheet), you just need to divide the two numbers. You will see such examples in the calculation of return on assets and return on equity later. Businesses communicate their financial results via their financial statements.