What is Vertical Analysis?Vertical analysis is the proportional analysis of a financial statement, where each line item on the statement is listed as a percentage of another item. This means that every line item on an income statement is stated as a percentage of gross sales, while every line item on a balance sheet is stated as a percentage of total assets. Show
What is Horizontal Analysis?Horizontal analysis is the comparison of historical financial information over a series of reporting periods. It is used to see if any numbers are unusually high or low in comparison to the information for bracketing periods, which may then trigger a detailed investigation of the reasons for the difference. Comparing Vertical Analysis and Horizontal AnalysisGiven these descriptions, the main difference between vertical analysis and horizontal analysis is that vertical analysis is focused on the relationships between the numbers in a single reporting period, while horizontal analysis spans multiple reporting periods.
Businesses communicate their financial results via their financial statements. If you look at an income statement and see a net income of $10,000, what will you say about this company? Good? Bad? So-so? And how can it be bad? It is making money? But what if this company is in an industry that every other competitors are all netting millions, and this one only netted $10,000? Thus, there is a need for financial statement analysis. When analyzing the financial data of a company, you can compare a company to itself. This is called intracompany comparison or analysis. You may wonder why do I need to compare me to myself? Well, perhaps you want to see if you make more money this year than last year. Or, you can compare your actual results to your budgeted amounts. On the other hand, you can also compare yourself to the entire industry. There are many industry standards available to you. At the UH Library, you can access an e-version of RMA. All industries are given a code and you simply look up the code for the industry a company belongs and you can compare your results to that of the industry. Below are some examples:
In addition, for the hospitality industry, Smith Travel Research (STR), CBRE, and HVS all provide various statistics, from operational to financial, for management and owners. If you work in the hotel segment of the hospitality industry and especially if you are in the front office, you might have heard of the the STAR report from STR. The three major tools for financial statement analyses are horizontal analysis, vertical analysis, and ratios analysis. You might have used some of them and just never knew their academic name. Horizontal analysis is also called comparative analysis. It is looking at least two points in time or in other words, over a period of time, to see how the account value changes. There are two calculations in horizontal analysis: $ change and % change. Vertical analysis is also called common size analysis, as the goal is to express each line-items as a % of a common base (thus the name common-size), where the base is always 100% and thus each line-item (or each account) makes up a percentage of the total. Ratios analysis is expressing relationships between two accounts where one number is divided into another to obtain a percentage, times, or a proportion. Take a look at the cash account in the example below. Again, horizontal analysis look at two points in time and calculate first the dollar change. Then, the dollar change is divided into the base (old, or beginning) amount to obtain the % change. It is the same principle as if you have your first raise in your first job. You made $10 an hour and now your boss gives you a raise and pays you $12. When you go home and share the good news with your parents, they ask, “What is the raise?”, and you say “$2” because you used your new pay $12 to minus your old pay “$10”. And, when they ask, “What is the percentage raise your boss gave you?”, and you say “20%” because you used your raise in dollar, $2, and divide that over your old pay of $10. Horizontal analysis dollar change = Current Year Amount – Base Year Amount Horizontal analysis percentage change = (Current Year Amount – Base Year Amount) / Base Year Amount Vertical analysis is also called common size analysis, as the goal is to express each line-items as a % of a common base (thus the name common-size), where the base is always 100% and thus each line-item (or each account) makes up a percentage of the total. There is only one calculation for vertical analysis – calculating the % of each individual account or line-items to the base – but depending on the statement, the base is different. For an income statement, the base is always the total revenues. And, if net revenues is given, then use net revenues. The logic is that revenues is the total, the entire pie so to speak, and everything is part of the total, part of the pie. For a balance sheet, the base is always total assets as that is what and how the company is made up of, such as how much of the company is made up of current assets or long-term assets. Since A = L + OE, then of course total liabilities and owner’s equity added together is also the base as these two numbers (A and L+OE) equal each other.
Ratios express the relationship among “selected” items of financial statement data from the income statement, balance sheet, SCF, departmental statement, and others. They can be expressed in the forms of percentage (such as profit, labor cost, food cost, etc.), per unit (such as average check), turnover (such as seat turnover in a restaurant), or coverage (such as current ratio or times interest earned). All ratios are the results of one number divided by another. If the two numbers are from the same statement (e.g. both from the income statement and both from the balance sheet), you just need to divide the two numbers. However, if one of the numbers come from a period statement such as and income statement, and one is from a dated statement such as a balance sheet, then you will need to average the beginning and ending values of the balance sheet accounts before dividing the numbers. You will see such examples in the calculation of return on assets and return on equity later. There are 5 major types of ratios:
In this class, we will concentrate on liquidity, solvency, and profitability and you will learn the others in your managerial accounting class. Liquidity RatiosLiquidity ratios measure the short-term ability of a business to pay its obligations and meet unexpected needs for cash. The two liquidity ratios we will cover here are current ratio and acid-test ratio:
Solvency RatiosSolvency ratios measures the ability of a company to survive over a long period of time, paying or covering its debt for the long-term. Two solvency ratios will be covered in this class:
Profitability RatiosProfitability ratios measure the net income or operating success of a company for a given period. As mentioned earlier, if one of the numbers come from a period statement such as an income statement, and one is from a dated statement such as a balance sheet, then you will need to average the beginning and ending values of the balance sheet accounts before dividing the numbers. Three profitability ratios are covered below:
Please calculate the following ratios for 2017 Liquidity
Solvency
Profitability
With the three tools of financial statement analysis, one can better understand the financial picture of a company, and therefore will be able to make better decisions for the operation. What are the 3 basic tools of financial statement analysis?Three of the most important techniques include horizontal analysis, vertical analysis, and ratio analysis.
What are vertical and horizontal analysis?Horizontal analysis is performed horizontally across time periods, while vertical analysis is performed vertically inside of a column. Horizontal analysis represents changes over years or periods, while vertical analysis represents amounts as percentages of a base figure.
What are the tools of analyzing financial statements?The three major tools for financial statement analyses are horizontal analysis, vertical analysis, and ratios analysis.
Is ratio analysis vertical analysis or horizontal analysis?Horizontal analysis is used in financial statement analysis to compare historical data, such as ratios or line items, over a number of accounting periods.
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