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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.

Table titled Vertical Analysis for Example Company, Income Statement, for the period ending December 31, 2022. There are two columns each named amount and percent for 2021 and 2022; the percent column is blank. The items and amounts are as follows:
Sales: 2021 $500,000, 2022 $550,000;
Sales returns and allowances: 2021 $25,000, 2022 $27,500;
Sales discounts: 2021 $12,500, 2022 $10,000;
Net sales: 2021 $462,500, 2022 $512,500; Cost of goods sold: 2021 $200,000, 2022 $205,000;
Gross profit: 2021 $262,500, 2022 $307,500;
Salaries expense: 2021 $120,000, 2022 $130,000;
Advertising expense: 2021 $15,000, 2022 $16,000,
Rent expense: 2021 $5,000, 2022 $6,000;
Insurance expense: 2021 $2,500, 2022 $2,500;
Supplies expense: 2021 $5,000, 2022 $5,000; Depreciation expense—buildings: 2021 $10,000, 2022 $10,000;
Total operating expenses: 2021 $157,500, 2022 $169,500;
Income from operations: 2021 $105,000, 2022 $138,000;

Other revenue (expenses), Interest expense: 2021 $2,000, 2022 $3,000;
Net income: 2021 $103,000, 2022 $135,000.
View this spreadsheet in Google Sheets

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%.

formula to know
Vertical Analysis
Vertical space Analysis equals fraction numerator Income space Statement space Item over denominator Net space Revenue end fraction

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.

EXAMPLE

Let's compare the salaries expense between 2021 and 2022.

You can see that in 2021, our salaries expense was 25.9% of our net sales.

Salaries space Expense space Vertical space Analysis equals fraction numerator Salaries space Expense over denominator Net space Revenue end fraction equals fraction numerator 120 comma 000 over denominator 462 comma 500 end fraction equals 25.9 percent sign

In 2022, salaries expense went down slightly to 25.4% of net sales.

Salaries space Expense space Vertical space Analysis equals fraction numerator Salaries space Expense over denominator Net space Revenue end fraction equals fraction numerator 130 comma 000 over denominator 512 comma 500 end fraction equals 25.4 percent sign

Therefore, not only can we look at the relationship within one year, but we can also look at that changing relationship over time.

Table titled Vertical Analysis for Example Company, Income Statement, for the period ending December 31, 2022. There are two columns each named amount and percent for 2021 and 2022; the percent column is blank. The items and amounts are as follows:
Sales: 2021 108.1%, 2022 107.3%;
Sales returns and allowances: 2021 5.4%, 2022 5.4%;
Sales discounts: 2021 2.7%, 2022 2.0%;
Net sales: 2021 100%, 2022 100%; Cost of goods sold: 2021 43.2%, 2022 40%;
Gross profit: 2021 56.8%, 2022 60%;
Salaries expense: 2021 25.9%, 2022 25.4%;
Advertising expense: 2021 3.2%, 2022 3.1%,
Rent expense: 2021 1.1%, 2022 1.2%;
Insurance expense: 2021 0.5%, 2022 0.5%;
Supplies expense: 2021 1.1%, 2022 1.2%; Depreciation expense—buildings: 2021 2.2%, 2022 2%;
Total operating expenses: 2021 34.1%, 2022 33.1%;
Income from operations: 2021 22.7%, 2022 26.9%;

Other revenue (expenses), Interest expense: 2021 0.4%, 2022 0.6%;
Net income: 2021 22.3%, 2022 26.3%.
View this spreadsheet in Google Sheets

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.

Table titled Vertical Analysis for Example Company, Balance Sheet, As of December 31, 2022. There are two columns each named amount and percent for 2021 and 2022; the percent column is blank. The items and amounts are as follows:
Assets, Cash: 2021 $40,000, 2022 $50,000;
Accounts receivable, 2021 $75,000, 2022 $80,000;
Merchandise inventory, 2021 $110,000, 2022 $100,000;
Supplies, 2021 $10,000, 2022 $12,000;
Prepaid insurance, 2021 $6,000, 2022 $6,000;
Land, 2021 $50,000, 2022 $50,000;
Buildings (net), 2021 $225,000, 2022 $215,000;
Total assets, 2021 $516,000, 2022 $513,000; Liabilities,
Accounts payable, 2021 $75,000, 2022 $85,000;
Sales tax payable, 2021 $25,000, 2022 $27,500;
Unearned revenue, 2021 $15,000, 2022 $20,000;
Notes payable, 2021 $200,000, 2022 $175,000;
Total liabilities, 2021 $315,000, 2022 $307,500;

Equity
Owner’s capital, 2021 $201,000, 2022 $205,500; Total liabilities and equity, 2021 $516,000, 2022 $513,000.
View this spreadsheet in Google Sheets

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.

EXAMPLE

Let's compare notes payable over the two years.

For 2021, you can see that our notes payable represents 38% of our total assets.

Notes space Payable space Vertical space Analysis equals fraction numerator Notes space Payable over denominator Total space Liabilities space and space Equity end fraction equals fraction numerator 200 comma 000 over denominator 516 comma 000 end fraction equals 38.8 percent sign

Then, if you look at the next year in 2022, you can see that notes payable only represents 34%.

Notes space Payable space Vertical space Analysis equals fraction numerator Notes space Payable over denominator Total space Liabilities space and space Equity end fraction equals fraction numerator 175 comma 000 over denominator 513 comma 000 end fraction equals 34.1 percent sign

Therefore, that composition is changing, which helps us to understand the relationship of that individual line item to our base amount.

Table titled Vertical Analysis for Example Company, Balance Sheet, As of December 31, 2022. There are two columns each named amount and percent for 2021 and 2022. The items and amounts are as follows:
Assets, Cash: 2021 7.8%, 2022 9.7%;
Accounts receivable, 2021 14.5%, 2022 15.6%;
Merchandise inventory, 2021 21.3%, 2022 19.5%;
Supplies, 2021 1.9%, 2022 2.3%;
Prepaid insurance, 2021 1.2%, 2022 1.2%;
Land, 2021 9.7%, 2022 9.7%;
Buildings (net), 2021 43.6%, 2022 41.9%;
Total assets, 2021 100%, 2022 100%; Liabilities,
Accounts payable, 2021 14.5%, 2022 16.6%;
Sales tax payable, 2021 4.8%, 2022 5.4%;
Unearned revenue, 2021 2.9%, 2022 3.9%;
Notes payable, 2021 38.8%, 2022 34.1%;
Total liabilities, 2021 61%, 2022 59.9%;

Equity
Owner’s capital, 2021 39%, 2022 40.1%; Total liabilities and equity, 2021 100%, 2022 100%.
View this spreadsheet in Google Sheets

hint
You can also find the value of the base amount if you know the line item and corresponding percentage. For instance, if we only knew that Buildings (net) was $22,5000 and that it made up 43.6% of our total assets, we could use the following equation to find the base amount for total assets:

Total space Assets cross times 0.436 equals Buildings space left parenthesis net right parenthesis

We can substitute $225,000 for the amount of buildings (net):

Total space Assets cross times 0.436 equals 225 comma 000

Then divide both sides by 43.6% or 0.436 to find the total assets amount of $516,000:

Total space Assets equals 225 comma 000 divided by 0.436 equals 516 comma 000

Note: this answer is rounded to the nearest thousand, or 516,000.

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.

Table titled Horizontal Analysis for Example Company, Income Statement, for the period ending December 31, 2022. The analysis has four columns, namely 2022, 2021, 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, 2022 $550,000, 2021 $500,000;
Sales returns and allowances, 2022 $27,500, 2021 $25,000;
Sales discounts, 2022 $10,000, 2021 $12,500;
Net sales, 2022 $512,500, 2021 $462,500;
Cost of goods sold, 2022 $205,000, 2021 $200,000;
Gross profit, 2022 $307,500, 2021 $262,500;
Salaries expense, 2022 $130,000, 2021 $120,000;
Advertising expense, 2022 $16,000, 2021 $15,000;
Rent expense, 2022 $6,000, 2021 $5,000;
Insurance expense, 2022 $2,500, 2021 $2,500;
Supplies expense, 2022 $5,000, 2021 $5,000;
Depreciation expense—buildings, 2022 $10,000, 2021 $10,000;
Total operating expenses, 2022 $169,500, 2021 $157,500;
Income from operations, 2022 $138,000, 2021 $105,000;

Other revenue (expenses), 
Interest expense, 2022 $3,000, 2021 $2,000;
Net income, 2022 $135,000, 2021 $103,000.
View this spreadsheet in Google Sheets

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. For instance, there was a $2,500 increase from 2021 to 2022 for Sales Returns and Allowances, however there was a $2,500 decrease in Sales Discounts from 2021 to 2022.

Sales space Returns space and space Allowances space Difference space left parenthesis $ right parenthesis equals 27 comma 500 minus 25 comma 000 equals 2 comma 500 Sales space Discounts space space Difference space left parenthesis $ right parenthesis equals 10 comma 000 minus 12 comma 500 equals short dash 2 comma 500

Table titled Horizontal Analysis for Example Company, Income Statement, for the period ending December 31, 2022. The analysis has four columns, namely 2022, 2021, 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, increase $50,000; Sales returns and allowances, increase $2,500; Sales discounts, decrease $2,500;
Net sales increase $50,000;
Cost of goods sold increase $5,000;
Gross profit increase $45,000; Salaries expense increase $10,000;
Advertising expense increase $1,000; Rent expense increase $1,000;
Insurance expense no increase or decrease; Supplies expense no increase or decrease; Depreciation expense—buildings no increase or decrease; Total operating expenses increase $12,000;
Income from operations increase $33,000;
Other revenue (expenses), Interest expense increase $1,000;
Net income increase $32,000.
View this spreadsheet in Google Sheets

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 2021 to 2022, 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.

Sales space Difference space left parenthesis percent sign right parenthesis equals fraction numerator 50 comma 000 over denominator 500 comma 000 end fraction equals 10 percent sign Rent space Difference space left parenthesis percent sign right parenthesis equals fraction numerator 1 comma 000 over denominator 5 comma 000 end fraction equals 20 percent sign

Table titled Horizontal Analysis for Example Company, Income Statement, for the period ending December 31, 2022. The analysis has four columns, namely 2022, 2021, increase or decrease amount, and increase or decrease percent. The rest of the items in the table are as follows:
Sales increase 10%; Sales returns and allowances increase 10%;
Sales discounts decrease 20%;
Net sales increase 10.8%;
Cost of goods sold increase 2.5%;
Gross profit increase 17.1%;

Salaries expense increase 8.3%;
Advertising expense increase 6.7%;
Rent expense increase 20%;
Insurance expense 0.0%;
Supplies expense 0.0%;
Depreciation expense—buildings 0.0%;
Total operating expenses increase 7.6%;
Income from operations increase 31.4%;
Other revenue (expenses), 
Interest expense increase 50%;
Net income increase 31.1%.
View this spreadsheet in Google Sheets

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.

Table titled Horizontal Analysis for Example Company, Balance Sheet, As of December 31, 2022. There are four columns named 2022, 2021, 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, 2022 $50,000, 2021 $40,000;
Accounts receivable, 2022 $80,000, 2021 $75,000;
Merchandise inventory, 2022 $100,000, 2021 $110,000;
Supplies, 2022 $12,000, 2021 $10,000;
Prepaid insurance, 2022 $6,000, 2021 $6,000;
Land, 2022 $50,000, 2021 $50,000;
Buildings (net), 2022 $215,000, 2021 $225,000;
Total assets, 2022 $513,000, 2021 $516,000;
Liabilities,
Accounts payable, 2022 $85,000, 2021 $75,000;
Sales tax payable, 2022 $27,500, 2021 $25,000;
Unearned revenue, 2022 $20,000, 2021 $15,000;
Notes payable, 2022 $175,000, 2021 $200,000;
Total liabilities, 2022 $307,000, 2021 $315,000;
Equity
Owner’s capital, 2022 $205,500, 2021 $201,000;
Total liabilities and equity, 2022 $513,000, 2021 $516,000.
View this spreadsheet in Google Sheets

The first thing we do is express the change in dollar amounts, in this case, from 2021 to 2022. 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.

Cash space Difference space left parenthesis $ right parenthesis equals 50 comma 000 minus 40 comma 000 equals 10 comma 000 Notes space Payable space Difference space left parenthesis $ right parenthesis equals 175 comma 000 minus 200 comma 000 equals short dash 25 comma 000

Table titled Horizontal Analysis for Example Company, Balance Sheet, As of December 31, 2022. There are four columns named 2022, 2021, 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 increase $10,000; Accounts receivable increase $5,000;
Merchandise inventory decrease $10,000;
Supplies increase $2,000;
Prepaid insurance no increase or decrease; Land no increase or decrease; Buildings (net) decrease $10,000; Total assets decrease $3,000;
Liabilities,
Accounts payable increase $10,000;
Sales tax payable increase $2,500;
Unearned revenue increase $5,000;
Notes payable decrease $25,000; Total liabilities decrease $7,500;
Equity
Owner’s capital increase $4,500;
Total liabilities and equity decrease $3,000.
View this spreadsheet in Google Sheets

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.

Supplies space Difference space left parenthesis percent sign right parenthesis equals fraction numerator 2 comma 000 over denominator 10 comma 000 end fraction equals 20 percent sign Unearned space Revenues space Difference space left parenthesis percent sign right parenthesis equals fraction numerator 5 comma 000 over denominator 15 comma 000 end fraction equals 33.3 percent sign Sales space Tax space Difference space left parenthesis percent sign right parenthesis equals fraction numerator 2 comma 500 over denominator 25 comma 000 end fraction equals 10 percent sign

Table titled Horizontal Analysis for Example Company, Balance Sheet, As of December 31, 2022. There are four columns named 2022, 2021, increase or decrease amount, and increase or decrease percent. The items in the table are as follows:
Assets,
Cash increase 25%;
Accounts receivable increase 6.7%;
Merchandise inventory decrease 9.1%;
Supplies increase 20%;
Prepaid insurance 0%;
Land 0%;
Buildings (net) decrease 4.4%;
Total assets decrease 0.6%;

Liabilities,
Accounts payable increase 13.3%; Sales tax payable increase 10%;
Unearned revenue increase 33.3%; Notes payable decrease 12.5%;
Total liabilities decrease 2.4%;
Equity,
Owner’s capital increase 2.2%;

Total liabilities and equity decrease 0.6%.
View this spreadsheet in Google Sheets

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: THIS TUTORIAL WAS AUTHORED BY EVAN MCLAUGHLIN FOR SOPHIA LEARNING. PLEASE SEE OUR TERMS OF USE.

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.

Formulas to Know
Vertical Analysis

Vertical space Analysis equals fraction numerator Income space Statement space Item over denominator Net space Revenue end fraction

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