Question

In regard to horizontal and vertical analysis do some research and answer why these methods are used. What can be learned from statements?  How can the results be compared to other corporations and why are ratios better than using dollars?

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Answer 1

In the vertical analysis, we take the sales as the base and then represent each line item as a percentage as sales. For example, we can calculate how much the operating expenses were as a percentage of sales. Therefore vertical analysis helps analyse as to which are the costs that are very high as a percentage of sales and helps us reduce the. We can also calculate as to how the net profit fares as a percentage to total sales and help improve the net income and reduce costs.

In horizontal analysis, we analyse the growth of each line item over the several years. For example, we can analysis, what was the year on year growth rate on the sales figure. Horizontal analysis helps us understand the areas in which the growth is happening in the business. This is especially useful in forecasting future year's earnings estimate.

We can use the results of the analysis from the company we are analysis and then compare it with the industry average (average numbers of all businesses in the industry) and we can see how our businesses performs when compared to others in the same industry.

Ratios are better than dollar. It is because, when we use the dollar amount, we may have the bias of selecting a larger business rather than a good performing business. If we use dollar amounts, we tend to select the biggest company. But ratios helps use select the best performing business and not the biggest.