What type of analysis expresses each item within a financial statement as a percent of a base?

Definition of Vertical Analysis

Vertical analysis expresses each amount on a financial statement as a percentage of another amount.

• The vertical analysis of a balance sheet results in every balance sheet amount being restated as a percent of total assets.
• The vertical analysis of an income statement results in every income statement amount being restated as a percent of net sales.

Example of Vertical Analysis of a Balance Sheet

If a company's inventory is $100,000 and its total assets are $400,000 the inventory will be expressed as 25% ($100,000 divided by $400,000). If cash is $8,000 then it will be presented as 2%($8,000 divided by $400,000). The total of the assets' percentages will add up to 100%. If the accounts payable are $88,000 they will be restated as 22% ($88,000 divided by $400,000). If owner's equity is $240,000 it will be shown as 60% ($240,000 divided by $400,000). The sum of the liabilities and owner's equity will also be 100%. The vertical analysis of the balance sheet will result in a common-size balance sheet. The percentages on a common-size balance sheet allow you to compare a small company's balance sheets to that of a very large company's balance sheet. A common-size balance sheet can also be compared to the average percentages for the industry.

Example of Vertical Analysis of an Income Statement

If a company's net sales were $1,000,000 they will be presented as 100% ($1,000,000 divided by $1,000,000). If the cost of goods sold amount is $780,000 it will be presented as 78% ($780,000 divided by sales of $1,000,000). If interest expense is $50,000 it will be presented as 5% ($50,000 divided by $1,000,000). The restated amounts result in a common-size income statement, since it can be compared to the income statement of a competitor of any size or to the industry's percentages.

Definition of Horizontal Analysis

Horizontal analysis looks at amounts from the financial statements over a horizon of many years. Horizontal analysis is also referred to as trend analysis. The amounts from past financial statements will be restated to be a percentage of the amounts from a base year.

Examples of Horizontal Analysis

To illustrate horizontal analysis, let's assume that a base year is five years earlier. All of the amounts on the balance sheets and the income statements will be expressed as a percentage of the base year amounts. The amounts from five years earlier are presented as 100% or simply 100. The amounts from the most recent years will be divided by the base year amounts. For instance, if a most recent year amount was three times as large as the base year, the most recent year will be presented as 300. If the previous year's amount was twice the amount of the base year, it will be presented as 200. Seeing the horizontal analysis of every item allows you to more easily see the trends. It will be easy to detect that over the years the cost of goods sold has been increasing at a faster pace than the company's net sales. From the balance sheet's horizontal analysis you may see that inventory and accounts payable have been growing as a percentage of total assets.

Vertical analysis, horizontal analysis and financial ratios are part of financial statement analysis.

Common‐size analysis (also called vertical analysis) expresses each line item on a single year's financial statement as a percent of one line item, which is referred to as a base amount. The base amount for the balance sheet is usually total assets (which is the same number as total liabilities plus stockholders' equity), and for the income statement it is usually net sales or revenues. By comparing two or more years of common‐size statements, changes in the mixture of assets, liabilities, and equity become evident. On the income statement, changes in the mix of revenues and in the spending for different types of expenses can be identified. 

A common‐size analysis for the latest two years of The Home Project Company is shown in the following example. To calculate the common‐size for the 20X1 balance sheet, each amount was divided by $114,538, the “total asset” amount. For the 20X0 balance sheet, the common‐size percentages were calculated by dividing by $118,732, “total assets.” For the 20X1 income statement, each amount was divided by $129,000 the “sales, net” amount, and for the 20X0 income statement, each amount was divided by $97,000, the “sales, net” amount
 .