Question

I agree that it is important to analyze the financial statements using comparative and horizontal analyses.
Do you think that vertical and horizontal analyses should be done independently of each other or together? Explain in your own words.

Answer 1

Horizontal and vertical analysis are two tools commonly used to assess organizational performance.

Horizontal analysis compares account balances and ratios over different time periods. Horizontal analysis allows investors and analysts to see what has been driving a company's financial performance over a number of years, as well as to spot trends and growth patterns such as seasonality. For example, you compare a company’s sales in 2019 to its sales in 2020. It is also known as compartative analysis.

Whereas, Vertical analysis restates each amount in the income statement as a percentage of a base amount. Using a vertical analysis aids in an enhanced decision-making process. It depicts the relationship between each line with a base amount. Each item on the statement is presented as a percentage of the base amount. For example, in 2019 XYZ Company has current assets of $500,000 and total assets of $1,500,500. To complete vertical analysis and convert current assets to a percentage, divide current assets of $500,000 by total assets of $1,500,500. Current assets represent 33% of the total assets.It is also known as common size financial statement analysis.

Reviewing these comparisons allows management and accounting staff at the company to isolate the reasons and take action to fix the problems.

Hence, both horizontal and vertical analysis are done independent of each other but are equally important for an organisation to assess its performance and take decision prudently.