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Vertical Analysis
Vertical analysis is a great starting point to understand how a company is performing. This method evaluates the individual line items on a financial statement by expressing them as a percentage of a base figure, such as total revenue. It offers insights into an organization’s financial health and is often referred to as common size financial statement analysis.
Vertical analysis is commonly applied to two types of financial statements: the income statement and the balance sheet. On the income statement, each line item is expressed as a percentage of total revenue, helping to understand the proportion of expenses and profits relative to sales. On the balance sheet, each line item is shown as a percentage of total assets, aiding in the analysis of a company’s financial position structure.
This method simplifies the comparison of financial performance across different periods, companies of varying sizes, or industry averages, making it easier to identify trends and areas of concern. By converting the data into percentages, vertical analysis allows for a clearer and more straightforward interpretation of financial information.
Horizontal Analysis
Horizontal analysis, also referred to as trend analysis, is a financial statement analysis tool that involves comparing specific line items across multiple time periods. This method helps individuals identify long-term financial trends within a business. By analyzing the percentage change in each line item over a given period, horizontal analysis provides valuable insights into a company’s financial health.
Horizontal analysis is particularly useful for comparing an organization’s performance over time and identifying changes in revenue, expenses, and profit. It supports businesses in making informed decisions about resource allocation and investment. Additionally, horizontal analysis effectively illustrates changes over time.
Horizontal Analysis Formula:
- (Current year value - Previous year value) / Previous year value × 100
The Power of Vertical and Horizontal Analysis
Vertical and horizontal analysis are powerful tools that provide valuable insights into a company’s financial health:
- Vertical Analysis: Enables financial experts to identify trends in a company’s finances by examining the proportion of each line item relative to a base amount. This facilitates well-informed decisions about resource allocation and prioritization.
- Horizontal Analysis: Allows individuals to compare the same line item across different periods, identifying trends in financial performance and guiding strategies for resource allocation and growth.
By leveraging these analytical methods, businesses and investors can gain a deeper understanding of financial trends, make strategic decisions, and optimize performance over time.
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Vertical Analysis Formulas: