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Vertical Analysis and Horizontal Analysis

Author: Sophia
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what's covered
This lesson will cover vertical analysis and horizontal analysis, used in the evaluation of financial statements. Specifically, this lesson will cover:

Table of Contents

1. Vertical Analysis

Let's begin today's lesson by discussing vertical analysis, which is used to evaluate financial statement items by expressing those items as a percent of a base amount.

Vertical analysis involves analyzing the relationship of each item on the financial statement to some base amount. So, for the balance sheet, for example, we will be expressing each item as a percentage of total assets. For the income statement, we will be expressing each item as a percent of net revenue.

We can use vertical analysis to evaluate how the percentages change over time:

  • We can look at changes within the company, which is an internal evaluation.
  • We can compare our company to others, which is an external evaluation.
  • We can look at industry standard, which is also an external analysis.
Now let's look at an example of how we perform vertical analysis.

1a. Income Statement

We're going to start with vertical analysis of our income statement, shown below. Again, vertical analysis is where we express these values as a percentage of a base amount.

Note, the base amount is going to be our net sales, and we have two years to compare.

This table titled “vertical analysis” for an example company shows the income statement for the period ending December 31, 2012. There are two columns each named amount and percent for 2011 and 2012; the percent column is blank. The items and amounts are as follows:
Sales, 2011 amount 500,000, 2012 amount 550,000
Sales returns and allowances, 2011 amount 25,000, 2012 amount 27,500
Sales discounts, 2011 amount 12,500, 2012 amount 10,000
Net sales, 2011 amount 462,500, 2012 amount 512,500
The amounts for the entry “Net Sales” are highlighted in the income statement.
Cost of goods sold, 2011 amount 200,000, 2012 amount 205,000
Gross profit, 2011 amount 262,500, 2012 amount 307,500

Salaries expense, 2011 amount 120,000, 2012 amount 130,000
Advertising expense, 2011 amount 15,000, 2012 amount 16,000
Rent expense, 2011 amount 5,000, 2012 amount 6,000
Insurance expense, 2011 amount 2,500, 2012 amount 2,500
Supplies expense, 2011 amount 5,000, 2012 amount 5,000
Depreciation expense—buildings, 2011 amount 10,000, 2012 amount 10,000
Total operating expenses, 2011 amount 157,500, 2012 amount 169,500
Income from operations, 2011 amount 105,000, 2012 amount 138,000

Other revenue (expenses) 
Interest expense, 2011 amount 10,000, 2012 amount 10,000

Net income, 2011 amount 103,000, 2012 amount 135,000

We're going to express all of these line items--sales returns and allowances, sales discounts, operating expenses, etc.--as a percentage of our base amount, which again, for the income statement, is our net sales.

Once we drop those figures in, below, if you look at the percentage column, you'll see that our base amount is our net sales, which represents 100%.

We're expressing all of these individual line items as a percentage of that base amount so that we can understand the relationship between these specific line items and that base amount.

For example, you can see that in 2011, our salaries expense was 25.9% of our net sales. In 2012, salaries expense went down slightly to 25.4% of net sales. Therefore, not only can we look at the relationship within one year, but we can also look at that changing relationship over time.

This table titled “vertical analysis” for an example company shows the income statement for the period ending December 31, 2012. There are two columns each named amount and percent for 2011 and 2012. The items, amounts, and percentages are as follows:
Sales, 2011 amount 500,000, percent 108.1%, 2012 amount 550,000, percent 103.7%
Sales returns and allowances, 2011 amount 25,000, percent 5.4%, 2012 amount 27,500, percent 5.4%
Sales discounts, 2011 amount 12,500, percent 2.7%, 2012 amount 10,000, percent 2.0%
Net sales, 2011 amount 462,500, percent 100.0%, 2012 amount 512,500, percent 100.0%
Cost of goods sold, 2011 amount 200,000, percent 43.2%, 2012 amount 205,000, percent 40.0%
Gross profit, 2011 amount 262,500, percent 56.8%, 2012 amount 307,500, percent 60.0%

Salaries expense, 2011 amount 120,000, percent 25.9%, 2012 amount 130,000, percent 25.4%,
The amounts and percentages for the entry “Salaries Expense” are highlighted in the income statement.
Advertising expense, 2011 amount 15,000, percent 3.2%, 2012 amount 16,000, percent 3.1%
Rent expense, 2011 amount 5,000, percent 1.1%, 2012 amount 6,000, percent 1.2%
Insurance expense, 2011 amount 2,500, percent 0.5%, 2012 amount 2,500, percent 0.5%
Supplies expense, 2011 amount 5,000, percent 1.1% 2012 amount 5,000, percent 1.0%
Depreciation expense—buildings, 2011 amount 10,000, percent 2.2%, 2012 amount 10,000, percent 2.0%
Total operating expenses, 2011 amount 157,500, percent 34.1%, 2012 amount 169,500, percent 33.1%
Income from operations, 2011 amount 105,000, percent 22.7%, 2012 amount 138,000, percent 26.9%

Other revenue (expenses) 
Interest expense, 2011 amount 10,000, percent 0.4%, 2012 amount 10,000, percent 0.6%

Net income, 2011 amount 103,000, percent 22.3%, 2012 amount 135,000, percent 26.3%

1b. Balance Sheet

Now, continuing with vertical analysis, we can do the same thing we we did for the income statement for the balance sheet. Again, we're going to express all of these individual line items of our balance sheet as a percentage of our base amount, which for the balance sheet is our total assets.

This table titled “vertical analysis” for an example company shows the balance sheet as of December 31, 2012. There are two columns each named amount and percent for 2011 and 2012; the percent column is blank. The items and amounts are as follows:
Assets
Cash, 2011 amount 40,000, 2012 amount 50,000
Accounts receivable, 2011 amount 75,000, 2012 amount 80,000
Merchandise inventory, 2011 amount 110,000, 2012 amount 100,000
Supplies, 2011 amount 10,000, 2012 amount 12,000
Prepaid insurance, 2011 amount 6,000, 2012 amount 6,000
Land, 2011 amount 50,000, 2012 amount 50,000
Buildings (net), 2011 amount 225,000, 2012 amount 215,000
Total assets, 2011 amount 516,000, 2012 amount 513,000
The amounts for the entry “Total Assets” are highlighted in the income statement.

Liabilities
Accounts payable, 2011 amount 75,000, 2012 amount 85,000
Sales tax payable, 2011 amount 25,000, 2012 amount 27,500
Unearned revenue, 2011 amount 15,000, 2012 amount 20,000
Notes payable, 2011 amount 200,000, 2012 amount 175,000
Total liabilities, 2011 amount 315,000, 2012 amount 307,000

Equity
Owner’s capital, 2011 amount 201,000, 2012 amount 205,500

Total liabilities and equity, 2011 amount 516,000, 2012 amount 513,000

So, if we express all of these financial statement line items as a percentage of our total assets, we can understand the relationship between these individual lines and our base amount.

For instance, you can see that our inventory represents 21% of our total assets, and that our notes payable represents 38% of our total assets. Then, if you look at the next year, you can see that notes payable only represents 34%. Therefore, that composition is changing, which helps us to understand the relationship of that individual line item to our base amount.

This table titled “vertical analysis” for an example company shows the balance sheet as of December 31, 2012. There are two columns each named amount and percent for 2011 and 2012. The items, amounts, and percentages are as follows:
Assets
Cash, 2011 amount 40,000, percent 7.8%, 2012 amount 50,000, percent 9.7%
Accounts receivable, 2011 amount 75,000, percent 14.5%, 2012 amount 80,000, percent 15.6%
Merchandise inventory, 2011 amount 110,000, percent 21.3%, 2012 amount 100,000, percent 19.3%
The amounts and percentages for the entry “Merchandise Inventory” are highlighted in the income statement.
Supplies, 2011 amount 10,000, percent 1.9%, 2012 amount 12,000, percent 2.3%
Prepaid insurance, 2011 amount 6,000, percent 1.2%, 2012 amount 6,000, percent 1.2%
Land, 2011 amount 50,000, percent 9.7%, 2012 amount 50,000, percent 9.7%
Buildings (net), 2011 amount 225,000, percent 43.6%, 2012 amount 215,000, percent 41.9%
Total assets, 2011 amount 516,000, percent 100.0%, 2012 amount 513,000, percent 100.0%

Liabilities
Accounts payable, 2011 amount 75,000, percent 41.5%, 2012 amount 85,000, percent 16.6%
Sales tax payable, 2011 amount 25,000, percent 4.8%, 2012 amount 27,500, percent 5.4%
Unearned revenue, 2011 amount 15,000, percent 2.9%, 2012 amount 20,000, percent 3.9%
Notes payable, 2011 amount 200,000, percent 38.8%, 2012 amount 175,000, percent 34.1%
The amounts and percentages for the entry “Notes Payable” are also highlighted in the income statement.
Total liabilities, 2011 amount 315,000, percent 61.0%, 2012 amount 307,000, percent 59.9%

Equity
Owner’s capital, 2011 amount 201,000, percent 39.0%, 2012 amount 205,500, percent 40.1%

Total liabilities and equity, 2011 amount 516,000, percent 100.0%, 2012 amount 513,000, percent 100.0%

term to know
Vertical Analysis
Evaluates financial statement items as a percent of a base amount.

2. Horizontal Analysis

Now that we've seen how to perform vertical analysis, let's turn our attention to horizontal analysis, which is used to evaluate percentage changes in financial statements from one period to another.

We are looking at the percentage changes within these individual financial statement items across periods, which helps us to analyze changes from one period to another. Now, not only can we express changes in percentages, but we can also express these changes in dollars, meaning we can see the percentage change of each line item as well as the dollar change of each of those financial statement items.

Again, this helps us to perform both internal and external comparisons, evaluating any internal changes within the company structure, or externally comparing ourselves to competitors, as well as industry standards.

Let's look at an example of performing horizontal analysis.

2a. Income Statement

Now, horizontal analysis is going to help us to look at these individual financial statement lines on our income statement, and how they are changing from one period to the next. Note, we are focusing on the individual line items and the changes within those line items themselves.

This horizontal analysis shows the income statement for an example company for the period ending December 31, 2012. The analysis has four columns, namely 2011, 2012, increase or decrease amount, and increase or decrease percent. The increase or decrease amount and percent columns are blank. The rest of the items in the table are as follows:
Sales, 2012 550,000, 2011 500,000
Sales returns and allowances, 2012 27,500, 2011 25,000
Sales discounts, 2012 10,000, 2011 12,500
Net sales, 2012 512,500, 2011 462,500
Cost of goods sold, 2012 205,000, 2011 200,000
Gross profit, 2012 307,500, 2011 262,500

Salaries expense, 2012 130,000, 2011 120,000
Advertising expense, 2012 16,000, 2011 15,000
Rent expense, 2012 6,000, 2011 5,000
Insurance expense, 2012 2,500, 2011 2,500
Supplies expense, 2012 5,000, 2011 5,000
Depreciation expense—buildings, 2012 10,000, 2011 10,000 
Total operating expenses, 2012 169,500, 2011 157,500
Income from operations, 2012 138,000, 2011 105,000

Other revenue (expenses) 
Interest expense, 2012 10,000, 2011 10,000

Net income, 2012 135,000, 2011 103,000

The first thing we can do is express those changes in dollar amounts so that we can see what the dollar increase or decrease is in these individual financial statement lines.

This horizontal analysis shows the income statement for an example company for the period ending December 31, 2012. The analysis has four columns, namely 2011, 2012, increase or decrease amount, and increase or decrease percent. The increase or decrease percent column is blank. The rest of the items in the table are as follows:
Sales, 2012 550,000, 2011 500,000, increase or decrease amount 50,000
Sales returns and allowances, 2012 27,500, 2011 25,000, increase or decrease amount 2,500
Sales discounts, 2012 10,000, 2011 12,500, increase or decrease amount 2,500
Net sales, 2012 512,500, 2011 462,500, increase or decrease amount 50,000
Cost of goods sold, 2012 205,000, 2011 200,000, increase or decrease amount 5,000
Gross profit, 2012 307,500, 2011 262,500, increase or decrease amount 45,000

Salaries expense, 2012 130,000, 2011 120,000, increase or decrease amount 10,000
Advertising expense, 2012 16,000, 2011 15,000, increase or decrease amount 1,000
Rent expense, 2012 6,000, 2011 5,000, increase or decrease amount 1,000
Insurance expense, 2012 2,500, 2011 2,500
Supplies expense, 2012 5,000, 2011 5,000
Depreciation expense—buildings, 2012 10,000, 2011 10,000 
Total operating expenses, 2012 169,500, 2011 157,500, increase or decrease amount 12,000
Income from operations, 2012 138,000, 2011 105,000, increase or decrease amount 33,000

Other revenue (expenses) 
Interest expense, 2012 10,000, 2011 10,000, increase or decrease amount 1,000

Net income, 2012 135,000, 2011 103,000, increase or decrease amount 32,000

Now we can convert that increase or decrease amount to a percentage, to show us the percentage increase or decrease of these individual financial statement lines, to better understand how they are changing over time.

We can see, for instance, that our sales increased 10% from 2011 to 2012, and rent expense went up 20%. Again, this helps us to understand the changes that are taking place at the individual financial statement line item.

This horizontal analysis shows the income statement for an example company for the period ending December 31, 2012. The analysis has four columns, namely 2011, 2012, increase or decrease amount, and increase or decrease percent. The increase or decrease percent column is blank. The rest of the items in the table are as follows:
Sales, 2012 550,000, 2011 500,000, increase or decrease amount 50,000, increase or decrease percent 10.0%
Sales returns and allowances, 2012 27,500, 2011 25,000, increase or decrease amount 2,500, increase or decrease percent 10.0%
The row for “Sales” is highlighted in the income statement.
Sales discounts, 2012 10,000, 2011 12,500, increase or decrease amount 2,500, increase or decrease percent negative 20.0%
Net sales, 2012 512,500, 2011 462,500, increase or decrease amount 50,000, increase or decrease percent 10.8%
Cost of goods sold, 2012 205,000, 2011 200,000, increase or decrease amount 5,000, increase or decrease percent 2.5%
Gross profit, 2012 307,500, 2011 262,500, increase or decrease amount 45,000, increase or decrease percent 17.1%

Salaries expense, 2012 130,000, 2011 120,000, increase or decrease amount 10,000, increase or decrease percent 8.3%
Advertising expense, 2012 16,000, 2011 15,000, increase or decrease amount 1,000, increase or decrease percent 6.7%
Rent expense, 2012 6,000, 2011 5,000, increase or decrease amount 1,000, increase or decrease percent 20.0%
The row for “Rent Expense” is highlighted in the income statement.
Insurance expense, 2012 2,500, 2011 2,500, increase or decrease percent 0.0%
Supplies expense, 2012 5,000, 2011 5,000, increase or decrease percent 0.0%
Depreciation expense—buildings, 2012 10,000, 2011 amount 10,000, increase or decrease percent 0.0%
Total operating expenses, 2012 169,500, 2011 amount 157,500, increase or decrease amount 12,000, increase or decrease percent 7.6%
Income from operations, 2012 138,000, 2011 105,000, increase or decrease amount 33,000, increase or decrease percent 31.4%

Other revenue (expenses) 
Interest expense, 2012 10,000, 2011 10,000, increase or decrease amount 1,000, increase or decrease percent 50.0%

Net income, 2012 135,000, 2011 103,000, increase or decrease amount 32,000, increase or decrease percent 31.1%

2b. Balance Sheet

Now we can perform the same horizontal analysis for our balance sheet. Again, we're looking at changes in the individual financial statement line items from one period to the next.

This table titled “horizontal analysis” for an example company shows the balance sheet as of December 31, 2012. There are four columns named 2012, 2011, increase or decrease amount, and increase or decrease percent. The increase or decrease amount and percent columns are blank. The rest of the items in the table are as follows:
Assets
Cash, 2012 50,000, 2011 40,000
Accounts receivable, 2012 80,000, 2011 75,000
Merchandise inventory, 2012 100,000, 2011 110,000
Supplies, 2012 12,000, 2011 10,000
Prepaid insurance, 2012 6,000, 2011 6,000
Land, 2012 50,000, 2011 50,000
Buildings (net), 2012 215,000, 2011 225,000
Total assets, 2012 513,000, 2011 516,000
The amounts for the entry “Total Assets” are highlighted in the income statement.

Liabilities
Accounts payable, 2012 85,000, 2011 75,000
Sales tax payable, 2012 27,500, 2011 25,000
Unearned revenue, 2012 20,000, 2011 15,000
Notes payable, 2012 175,000, 2011 200,000
Total liabilities, 2012 307,000, 2011 315,000

Equity
Owner’s capital, 2012 205,500, 2011 201,000

Total liabilities and equity, 2012 513,000, 2011 516,000

The first thing we do is express the change in dollar amounts, in this case, from 2011 to 2012. We want to know, from a dollar perspective, how these individual financial statement line items are changing.

As you can see, for example, cash increased $10,000 and notes payable went down $25,000.

This table titled “horizontal analysis” for an example company shows the balance sheet as of December 31, 2012. There are four columns named 2012, 2011, increase or decrease amount, and increase or decrease percent. The increase or decrease percent column is blank. The rest of the items in the table are as follows:
Assets
Cash, 2012 50,000, 2011 40,000, increase or decrease amount 10,000
The row for “Cash” is highlighted in the balance sheet.
Accounts receivable, 2012 80,000, 2011 75,000, increase or decrease amount 5,000
Merchandise inventory, 2012 100,000, 2011 110,000, increase or decrease amount 10,000
Supplies, 2012 12,000, 2011 10,000, increase or decrease amount 2,000
Prepaid insurance, 2012 6,000, 2011 6,000, increase or decrease amount
Land, 2012 50,000, 2011 50,000, increase or decrease amount
Buildings (net), 2012 215,000, 2011 225,000, increase or decrease amount 10,000
Total assets, 2012 513,000, 2011 516,000, increase or decrease amount 3,000

Liabilities
Accounts payable, 2012 85,000, 2011 75,000, increase or decrease amount 10,000
Sales tax payable, 2012 27,500, 2011 25,000, increase or decrease amount 2,500
Unearned revenue, 2012 20,000, 2011 15,000, increase or decrease amount 5,000
Notes payable, 2012 175,000, 2011 200,000, increase or decrease amount 25,000
The row for “Notes Payable” is highlighted in the balance sheet.
Total liabilities, 2012 307,000, 2011 315,000, , increase or decrease amount 7,500

Equity
Owner’s capital, 2012 205,500, 2011 201,000, increase or decrease amount 4,500

Total liabilities and equity, 2012 513,000, 2011 516,000, increase or decrease amount 3,000

Next we can convert increase or decrease in dollars to a percentage, to increase our understanding of what changes are taking place.

For instance, supplies went up 20% and unearned revenues also went up by 33%. Sales tax payable went up 10%, which makes sense if you think back to our income statement, because our sales were increasing.

This table titled “horizontal analysis” for an example company shows the balance sheet as of December 31, 2012. There are four columns named 2012, 2011, increase or decrease amount, and increase or decrease percent. The items in the table are as follows:
Assets
Cash, 2012 50,000, 2011 40,000, increase or decrease amount 10,000, increase or decrease percent 25.0%
Accounts receivable, 2012 80,000, 2011 75,000, increase or decrease amount 5,000, increase or decrease percent 6.7%
Merchandise inventory, 2012 100,000, 2011 110,000, increase or decrease amount 10,000, increase or decrease percent negative 9.1%
Supplies, 2012 12,000, 2011 10,000, increase or decrease amount 2,000, increase or decrease percent 20.0%
The row for “Supplies” is highlighted in the balance sheet.
Prepaid insurance, 2012 6,000, 2011 6,000, increase or decrease amount, increase or decrease percent 0.0%
Land, 2012 50,000, 2011 50,000, increase or decrease amount, increase or decrease percent 0.0%
Buildings (net), 2012 215,000, 2011 225,000, increase or decrease amount 10,000, increase or decrease percent negative 4.4%
Total assets, 2012 513,000, 2011 516,000, increase or decrease amount 3,000, increase or decrease percent negative 0.6 %

Liabilities
Accounts payable, 2012 85,000, 2011 75,000, increase or decrease amount 10,000, increase or decrease percent 13.3%
Sales tax payable, 2012 27,500, 2011 25,000, increase or decrease amount 2,500, increase or decrease percent 10.0%
The row for “Sales tax payable” is highlighted in the balance sheet.
Unearned revenue, 2012 20,000, 2011 15,000, increase or decrease amount 5,000, increase or decrease percent 33.3%
The row for “Unearned revenue” is highlighted in the balance sheet.
Notes payable, 2012 175,000, 2011 200,000, increase or decrease amount 25,000, increase or decrease percent negative 12.5%
Total liabilities, 2012 307,000, 2011 315,000, , increase or decrease amount 7,500, increase or decrease percent negative 2.4%

Equity
Owner’s capital, 2012 205,500, 2011 201,000, increase or decrease amount 4,500, increase or decrease percent 2.2%

Total liabilities and equity, 2012 513,000, 2011 516,000, increase or decrease amount 3,000, increase or decrease percent negative 0.6%

term to know
Horizontal Analysis
Evaluates percentage changes in financial statement items from one period to another.

summary
Today's tutorial was all about analysis. We learned about vertical analysis, which evaluates financial statement items as a percent of a base amount. We also learned about performing horizontal analysis, which evaluates percentage changes in financial statement items from one period to another. We explored examples of performing both of types of analysis on an income statement and balance sheet.

Source: Adapted from Sophia instructor Evan McLaughlin.

Terms to Know
Horizontal Analysis

Evaluates percentage changes in financial statement items from one period to another.

Vertical Analysis

Evaluates financial statement items as a percent of a base amount.

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