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Analyzing a single period financial statement works well with vertical analysis. On the income statement, percentages represent the correlation of each separate account to net sales. Express all accounts other than net sales as a percentage of net sales. Net income represents the percentage of net sales not used on expenses. For example, if expenses total69 percent of net sales, net income represents the remaining31 percent. Vertical analysis performed on balance sheets uses total assets and total liabilities for comparison of individual balance sheet accounts.
Horizontal Analysis
Horizontal analysis is the comparison of data sets for two periods. Financial statements users review the change in data much like an indicator. Optimistic analysts look for growth in revenue, net income and assets in addition to reductions in expenses and liabilities. Calculating absolute dollar changes requires the user to subtract the base figure from the current figure. Expressing changes with percentages requires the user to divide the base figure by the current figure, and multiply by100.
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 $100,000 and total assets are $400,000 then inventory is presented as25% ($100,000 divided by $400,000). If cash is $8,000 then it will be presented as2% ($8,000 divided by $400,000). If the accounts payable are $88,000 they will be presented as22% ($88,000 divided by $400,000). If owner's equity is $240,000 it will be presented as60% ($240,000 divided by $400,000). The total of the assets will be equal to100%. The restated amounts from the vertical analysis of the balance sheet will be presented as a common-size balance sheet.
Vertical analysis of an income statement results in every income statement amount being presented as a percentage of sales. If sales were $1,000,000 they would be restated to be100% ($1,000,000 divided by $1,000,000). If the cost of goods sold is $780,000 it will be presented as78% ($780,000 divided by sales of $1,000,000). If interest expense is $50,000 it will be presented as5% ($50,000 divided by $1,000,000). The restated amounts are known as a common-size income statement.
A ommon-size balance sheet and common-size income statement allow you to compare your company's balance sheet and income statement to another company's or to the industry average.
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 December31 of2012,2011,2010,2009, and2008 will be expressed as a percentage of the December31,2008 amount. Instead of dollar amounts you might see134,125,110,103, and100. This shows that the amount of cash at the end of2012 is134% of the amount it was at the end of2008. 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. Vertical analysis, horizontal analysis and financial ratios are part of financial statement analysis.
