Vertical analysis is a method used in financial reporting where each line item on a financial statement is listed as a percentage of another item. This allows finance teams to see the relative sizes of accounts.
Vertical analysis can be applied to income statements, where items are often expressed as a percentage of sales, or balance sheets, where items are shown as a percentage of total assets.
Vertical analysis can be incredibly beneficial to finance teams. Some of the key benefits include:
Conducting vertical analysis starts by selecting a base amount for each financial statement. For an income statement, this might be total revenue or net sales. For a balance sheet, it might be total assets or total liabilities and equity.
Next, you would calculate the percentage that each line item represents of that base amount. This process turns financial statements into digestible, comparative data. To calculate the percentage that each line item represents of the base amount, you can use the following formula:
Percentage of base amount = (Line item amount / Base amount) * 100
For example, let’s say your company's cost of goods sold (COGS) is 40% of total sales one year. Then the next year, it rises to 50%. Vertical analysis would help you quickly flag this increase, allowing you to dig deeper into potential causes like rising material costs, pricing strategies, etc.
When conducting vertical analysis, be sure to follow these best practices to get the best results:
Horizontal analysis, also known as trend analysis, involves comparing line items in financial statements from one period to the next, either in terms of absolute changes or percentage changes.
This type of analysis is useful for spotting trends, understanding growth patterns, or identifying potential financial concerns.
There are plenty of advantages to using horizontal analysis in financial planning. Some of the key advantages include:
Performing horizontal analysis involves a few straightforward steps. First, you’ll decide which financial periods you want to compare. This could be consecutive years, quarters, or months, depending on the level of detail you need.
Then, for each line item you're analyzing, you’ll want to calculate both the absolute change (the difference in value from one period to the next) and the percentage change (the rate of change over time).
Absolute change = Value in current period − Value in previous period
Percentage change = (Absolute change / Value in previous period) * 100
Imagine that a company has been gradually increasing its marketing expenditure over five years. With horizontal analysis, the company could:
When conducting horizontal analysis, be sure to follow these best practices to get the best results:
We’ve already discussed how vertical analysis and horizontal analysis benefit finance teams on their own—but when combined, they can provide finance teams with an even greater understanding of their company's financial health.
Imagine looking at a building from only the front view. You’ll get a certain idea of its design—but once you also look at it from the side, you’ll start to understand its depth and structure much better.
Vertical analysis is like viewing the building from the front. It looks at financial statements to see how each part relates to a whole within a single period. Horizontal analysis, on the other hand, is like viewing the building from the side. It compares those parts over different periods to help you understand its changes over time.
By combining both types of analysis, you get a fuller, more detailed picture of your company's financial health and performance trends, allowing you to make more informed decisions.
There’s just one question: how do you integrate vertical and horizontal analysis into the FP&A process?
Start by using vertical analysis to understand the proportionate importance of each financial statement item at a specific point in time. Then, use horizontal analysis to track how these proportions change over time. This cross-analysis will reveal your company’s current financial composition and how that composition evolves over time, making it easier to spot underlying trends and anomalies.
The insights gained during this process can significantly inform strategic planning and investment decisions. For example, identifying a consistent increase in cost of goods sold as a percentage of sales (from vertical analysis) alongside overall revenue and gross profit growth (from horizontal analysis) may prompt strategies to improve cost efficiency or pricing models.
While they can certainly be beneficial, applying vertical and horizontal analyses in the midmarket segment comes with its own set of challenges.
These challenges may include:
Addressing these challenges and thoughtfully integrating vertical and horizontal analysis can enhance your FP&A processes, lead to more informed strategic decisions, and improve financial performance.
Vertical and horizontal analysis are key for anyone in FP&A looking to get a clear picture of their company’s financial situation. Together, they can help you see not just where your business stands today, but how it’s been moving over time—and where it’s headed in the future. Be sure to follow the tips provided to pinpoint where your company is doing well and where you need to improve.
Want to learn how Cube can help make this process easier and more efficient? Request a free demo today.