Question

What do horizontal and vertical and ratio analysis mean in accounting?

Please provide an explanation with some examples.

Answer 1

First lets see what is similar, in both vertical & horizontal analysis. Both these analyses are done to get more information about a company's balance sheet and Income statement & their composition.

The words horizontal & vertical come from the direction in which the financial statements are analyzed.

Horizontal would mean the analysis is .one for different periods. Typically left to right in a spreadsheet or a book (check example). This analyze would be used when an analyst wants to check how a firm has done over the years to make reasonable forecasts in to the future. Ex: To compare Net profit margins over the years. (Income statement), or to see how Current ratio (Balance sheet) has changed over the years. Asset turnover evolution over the years is another example of a horizontal analysis. This type of analysis is always inter- periods.

Vertical analysis is done check for the composition of a balance sheet or income statement. This analysis is from top to bottom of a particular years. In other words it analyses the balance sheet/Income only for one period.

If an analyst wants to find out, where majority expenses of a firm are coming from, he could use a vertical analysis and a find out the different kind of expenses and express them as a percentage of that years Revenue. The same is done with the balance sheet. To check where the majority of liabilities come for a firm, an analyst can express short term and long term liabilities as a percentage of total liabilities. This will give him a better idea of where the firms liabilities come from (short term vs long term)

Please check image as well. The tabs in red represent vertical analysis and the ones in green represent horizontal analysis.

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