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Analysis of financial statements

amulya (always ready to learn) (79 Points)

03 May 2011

what is the difference between horizontal and vertical analysis?

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Sk. Abdul Aziz (CA - Final) (811 Points)
Replied 03 May 2011

Vertical analysis reports each amount on a financial statement as a percentage of another item. For example, the vertical analysis of the balance sheet means every amount on the balance sheet is restated to be a percentage of total assets. If inventory is 100000 and total assets are 400000 then inventory is presented as 25 (100000 divided by 400000). If cash is 8000 then it will be presented as 2 (8000 divided by 400000). The total of the assets will now add up to 100. If the accounts payable are 88000 they will be presented as 22 (88000 divided by 400000). If owner’s equity is 240000 it will be presented as 60 (240000 divided by 400000). The restated amounts from the vertical analysis of the balance sheet will be presented as a common-size balance sheet. A common-size balance sheet allows you to compare your company’s balance sheet to another company’s balance sheet or to the average for its industry.
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Vertical analysis of an income statement results in every income statement amount being presented as a percentage of sales. If sales were 1000000 they would be restated to be 100 (1000000 divided by 1000000). If the cost of goods sold is 780000 it will be presented as 78 (780000 divided by sales of 1000000). If interest expense is 50000 it will be presented as 5 (50000 divided by 1000000). The restated amounts are known as a common-size income statement. A common-size income statement allows you to compare your company’s income statement to another company’s or to the industry average.
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Horizontal analysis looks at amounts on the financial statements over the past years. For example, the amount of cash reported on the balance sheet at December 31 of 2006, 2005, 2004, 2003, and 2002 will be expressed as a percentage of the December 31, 2002 amount. Instead of rupee amounts you might see 134, 125, 110, 103, and 100. This shows that the amount of cash at the end of 2006 is 134% of the amount it was at the end of 2002. The same analysis will be done for each item on the balance sheet and for each item on the income statement. This allows you to see how each item has changed in relationship to the changes in other items. Horizontal analysis is also referred to as trend analysis.
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Vertical analysis, horizontal analysis and financial ratios are part of financial statement analysis.