Company Financial Statement Analysis & Interpretation Of Financial Statements

 In Bookkeeping

horizontal and vertical analysis

This helps you easily recognise changes in your organisation over time and view any significant profits or losses. Vertical analysis breaks down your financial statements line-by-line to give you a clear picture of the day-to-day activity on your company accounts.

horizontal and vertical analysis

Horizontal analysis allows for a finance professional to analyse all the amounts in a financial statement that have been accumulated over the previous two or more periods since the company have conducted business. Vertical analysis involves taking the information on the financial statements and comparing all the numbers to a single number on the statement. For instance, on the Income Statement, all the accounts are expressed as a percentage of sales . Horizontal analysis uses a line-by-line comparison to compare the totals.

Example Of Horizontal Analysis

By using horizontal analysis, we can now clearly see that Google’s revenue, gross profit, and EBITDA grew faster than Apple’s in every year except for 2015 , with 2016 looking particularly rough for Apple. Horizontal analysis, also called time series analysis, focuses on trends and changes in numbers over time. Horizontal allows you to detect growth patterns, cyclicality, etc., and to compare these factors among different companies. Horizontal allows you to detect growth patterns, cyclicality, etc. and to compare these factors among different companies. For example, an analyst may get excellent results when the current period’s income is compared with that of the previous quarter. However, the same results may be below par when the base year is changed to the same quarter for the previous year. To illustrate, consider an investor who wishes to determine Company ABC’s performance over the past year before investing.

  • By doing the same analysis for each item on the balance sheet and income statement, one can see how each item has changed in relationship to the other items.
  • For the balance sheet, the items of the sheet are divided by total assets.
  • The method also enables the analysis of relative changes in different product lines and projections into the future.
  • This causes difficulties since it’s hard to compare companies of different sizes.
  • It involves identifying the co-relation of items relating to a company’s financial information and how they affect the overall performance of an organization.

Current Ratio is the relationship between a company’s current assets and current liabilities. This form of liquidity ratio also shows if the company can pay its current liabilities. A company’s current ratio can be formulated by dividing the current assets by the current liabilities. In 2016, Starbucks had a ratio of 1.05, which shows that the company has 5% cash and assets that could cover all current liabilities, thus it should not have any problems paying its current liabilities.

Company Overview Of The Coca Cola Company

Thereby, achieving a goal of the budgeting process to determine the firm’s game plan. This ratio is a measure of the ability of a firm to turn Inventory into Sales. In this case, the higher the ratio, the better the business is using Inventory. Because they are turning over their Inventory without the cost of it becoming obsolete. Vertical analysis makes it easy to identify the relative size of the components of a financial statement and their total size.

The method also enables the analysis of relative changes in different product lines and projections into the future. Whether you do a horizontal analysis quarterly or yearly, it’s worth the time and effort to perform this calculation regularly. E.g. HGY Company’s income statement for the year ended 2016 is shown below along with the financial results for the year 2015.

horizontal and vertical analysis

The vertical analysis of an income statement results in every income statement amount being restated as a percent of net sales. The purpose of vertical analysis is to evaluate the trend of a specific item with an everyday item within the current year. Here, the vertical analysis can be used to understand the different proportions of each line item to the whole statement, and hence understand the trends for the current fiscal year. The vertical analysis considers each amount on the financial statement listed as a percentage of another amount.

Difference Between Vertical Analysis And Horizontal Analysis

In vertical analysis, balance sheet items and income statement items are expressed in percentage. All balance sheet accounts are presented as a percentage of the total assets and all income statement items are presented as a percentage of sales (Ott, Riddiough, & Yi, 2009). Sales is assumed to be equal to 100, for income statement and total assets is assumed to be common based equal to 100 in case of balance sheet. In contrast, horizontal analysis looks at line items by how they have changed over a period of time. When a company releases this type of financial statement, it will often additionally include columns that compare line items to those reported in a previous period for comparison.

horizontal and vertical analysis

For vertical analysis, a base line item in the financial statements is chosen and all other line items are expressed in percentage terms relative to the selected base item. If a company’s inventory is $100,000 and its total assets are $400,000 the inventory will be expressed as 25% ($100,000 divided by $400,000). If cash is $8,000 then it will be presented as 2%($8,000 divided by $400,000). If the accounts payable are $88,000 they will be restated as 22% ($88,000 divided by $400,000). If owner’s equity is $240,000 it will be shown as 60% ($240,000 divided by $400,000). The vertical analysis of the balance sheet will result in a common-size balance sheet.

Example Of Vertical Analysis Of A Balance Sheet

Examining the vertical analysis of the income statement, one can see that all three net revenue categories – company-operated stores (79%), licensed stores (10%), and CPG (11%) – have the same percentage from both years. Similar to net revenues, the 2016 expenses and net earnings have very similar percentages to those of 2015. If a company’s net sales were $1,000,000 they will be presented as 100% ($1,000,000 divided by $1,000,000). If the cost of goods sold amount is $780,000 it will be presented as 78% ($780,000 divided by sales of $1,000,000). If interest expense is $50,000 it will be presented as 5% ($50,000 divided by $1,000,000). The restated amounts result in a common-size income statement, since it can be compared to the income statement of a competitor of any size or to the industry’s percentages. The concepts of horizontal and vertical analysis have been primary contributing tools for the expansion of businesses for the past many years.

  • We have no way of knowing, because we don’t know the cash positions of Companies A and B, how profitable Companies A and B are, etc.
  • Regardless, accounting changes and one-off events can be used to correct such an anomaly and enhance horizontal analysis accuracy.
  • Cost Of Goods SoldThe Cost of Goods Sold is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs.
  • Ask Any Difference is made to provide differences and comparisons of terms, products and services.
  • A few years ago we as a company were searching for various terms and wanted to know the differences between them.
  • For example, by showing the various expense line items in the income statement as a percentage of sales, one can see how these are contributing to profit margins and whether profitability is improving over time.
  • Horizontal analysis is used to indicate changes in financial performance between two comparable financial quarters including quarters, months or years.

It will be easy to detect that over the years the cost of goods sold has been increasing at a faster pace than the company’s net sales. From the balance sheet’s horizontal analysis you may see that inventory and accounts payable have been growing as a percentage of total assets. Although both horizontal and vertical analysis is used in the analysis of financial statements, they have several differences.

Horizontal Analysis Vs Vertical Analysis: What’s The Difference?

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. Adding a third year to the analysis will be even more helpful, as you’ll be able to see if there is a definite trend. Vertical analysis is used in order to gain a picture of whether performance metrics are improving or deteriorating. Mitchell Grant is a self-taught investor with over 5 years of experience as a financial trader.

For example, if you run a comparative income statement for 2018 and 2019, horizontal analysis allows you to compare revenue totals for both years to see if it increased, decreased, or remained relatively stagnant. In horizontal analysis, the items of the present financial year are compared with the base year’s amount, horizontal and vertical analysis in both absolute and percentage terms. On the contrary, in vertical analysis, each item of the financial statement is compared with another item of that financial statement. In Horizontal Financial Analysis, the comparison is made between an item of financial statement, with that of the base year’s corresponding item.

Cost Of SalesThe costs directly attributable to the production of the goods that are sold in the firm or organization are referred to as the cost of sales. For example, to find the growth rate of net sales of 2015, the formula is (Net Sales 2015 – Net Sales 2014) / Net Sales 2014. Likewise, we can do the same for all the other entries in the income statement. First, we need to take the previous year as the base year and last year as the comparison year. As we see, we can correctly identify the trends and develop relevant areas to target for further analysis. Thus, it will be best not to use vertical analysis as a tool to get an answer but use it to figure out what questions one may ask. We can even take this one step further by calculating the compound annual growth rate for each line item from 2014 to 2018.

What Is Horizontal Analysis?

Usually, it is the total asset, but one also can use total liabilities for calculating the percentage of all liability line items. Such an analysis helps evaluate the changes in the working capital and fixed assets over time.

Percentages are worked on the basis of a selected base year and then compared. Conduct a horizontal analysis of Apple Inc.’s income statement and provide your insights on the same. The search for answers to these questions begins with an analysis of the firm’s Financial Statements.

The technique shows whether or not the company is expanding and appreciating in terms of value. Therefore, an investor can easily track a company’s earnings per share ratio, using this analysis balance sheet before making an investment decision. If the analysis shows constant growth year after another, it means that there is a positive trend. So, any investor would most likely prefer to invest in the company and vise versa. When it comes to management, it is mostly concerned with the company’s daily operations. So, it may want to use this technical analysis to point out areas that need improvement and that which it should maintain. For instance, the management might compare the cost of goods the company has sold and the realized profit margin over a span of either two or three years.

Key Differences Between Horizontal And Vertical Analysis

We can similarly analyze other aspects such as, dividend payout has increased from 21 million to 30 million, an increase by 23%. The income statement with the help of vertical analysis has helped understand that the company has performed well as compared to previous year. Horizontal and vertical analyses are analytical tools frequently used to analyze financial statements. What type of information or insights can be obtained by using these two techniques? Explain how the output of horizontal analysis and vertical analysis can be compared to industry averages and/or competitive companies.

In your accounts and any growth or decline that may have occurred over set periods of time. In this, each line item is compared with another item in terms of percentages to make decisions. Financial analysis helps top management to assess whether the firm resources are utilized in an efficient manner and also helps in investigating future prospects of the enterprise. For example, if the selling expenses https://www.bookstime.com/ over the past years have been in the range of 40-45% of gross sales. For the current year, they suddenly jump to say 50%; this is something that management should check. Horizontal analysis is the comparison of historical financial information over various reporting periods. Calculate the percentage change by dividing the absolute change by amount of base year and multiplying the result by 100.

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