We are facing the simplest and most useful financial analysis techniques. Both allow us to know, for example, that our machinery accounts for 30% of our total fixed assets and that compared to the previous year, that percentage has risen by 5%.
In this way, with the vertical analysis, the company can know the percentage of each item on an equity mass of its balance sheet, such as non-current assets. With the horizontal you can obtain information on the evolution of each item from one year to another.
Rationale for vertical and horizontal analysis
When a company prepares its annual accounts, balance sheet and income statement, it must also analyze them. In this way, the vertical and horizontal analysis is an easy starting point that can be done with a spreadsheet.
From the vertical analysis, the company will decide if it has too much debt, non-current assets, or other accounts and will take corrective action where appropriate. From the horizontal you will be able to check if an income statement has increased or decreased and if necessary, correct the deviation.
How to perform both types of analysis
We will show how to perform both types of analysis and we will complement it with an example at the end of this definition to better understand it.
- In the vertical analysis, each item of assets, net worth, liabilities and income items is divided among a group of these, for example, the patrimonial masses. In this way we will know the proportions on an aggregate data of several of them.
- In the horizontal analysis, what we do is calculate the variation rates of each item from one year to another. In this way, we will be able to know its evolution over time and if it has been positive or negative, that is, if it has increased or decreased.
Example of vertical and horizontal analysis
Imagine a company that has a balance sheet like the one shown in the figure. We have simplified the example for simplicity. On the other hand, we have calculated the proportions (vertical) and rates of variation (horizontal).
We include, as an example, the formulas used for machinery and non-current assets. For the vertical analysis, we divide the value of machinery by the value of non-current assets and multiply by 100 to express it as a percentage of one over the other.
In the case of the horizontal analysis, it is an annual variation rate. We subtract the value of the most recent year (2) minus the previous one (1) and divide everything by the last one (1). Once again we express everything in percentages by multiplying by 100.
We observe several things. In the first place, non-current assets account for slightly more than 60% of total assets in the first year (Av1) and fall to 51% in the second (Av2). The composition of current assets increases from one year to the next, above all because of the treasury.
In relation to net worth, this also increases its composition thanks to reserves. There is also a reduction in non-current liabilities due to the amortization of long-term debt. In addition, suppliers have increased, but that of creditors has decreased.
The horizontal analysis (AH) is done only in one column, since the variation rate includes both years. We highlight the 20% annual reduction of all items of non-current assets due to depreciation, which we have considered the same in all of them for simplicity purposes.
Finally, we observe the reduction of clients or the increase of reservations and suppliers from one year to another. As we can see, vertical and horizontal analysis is very useful to provide relevant accounting information. With it we can make better decisions in the future.