1. Horizontal analysis

Horizontal, or trend analysis, is the analysis of the data for a specific financial statement item as reported over a period of time, showing year to year or quarterly changes in terms of dollars or percentage of change:

Absolute Dollars

One method of performing a horizontal financial statement analysis compares the absolute dollar amounts of certain items over a period of time. For example, this method would compare the actual dollar amount of operating expenses over a period of several accounting periods. This method is valuable when trying to determine whether a company is conservative or excessive in spending on certain items. This method also aids in determining the effects of outside influences on the company, such as increasing gas prices or a reduction in the cost of materials.

Percentage

The other method of performing horizontal financial statement analysis compares the percentage difference in certain items over a period of time. The dollar amount of the change is converted to a percentage change. For example, a change in operating expenses from $1,000 in period one to $1,050 in period two would be reported as a 5% increase. This method is particularly useful when comparing small companies to large companies.

Trend percentages can be calculated when multiple periods are reviewed and compared against the chosen base year. Both the dollar changes and percentage changes associated with the specific areas of analysis on the financial statements must be given consideration as to not allow one of the results to be given unearned significance. For instance, a specific dollar amount may not be correctly judged in its significance when not viewed in relation to actual percentage of change. Realizing the trends associated with the specific focus of analysis assists in setting more realistic goals for the future and preparing a budget that more closely reflects the most likely scenario for operational performance. Proper planning and budgeting, as produced through horizontal analysis, will ensure that all necessary resources are available to meet the anticipated demands of the organization.

Methods of financial statement analysis generally involve comparing certain information. The horizontal analysis compares specific items over a number of accounting periods. For example, accounts payable may be compared over a period of months within a fiscal year, or revenue may be compared over a period of several years.

2. Vertical Analysis

Vertical financial statement analysis focuses on the relationships of the many different elements within the financial statement for a single reporting period. Vertical analysis produces a percentage representative of the portion of the individual items or activities as they relate to a larger, or overall item, activity, or view of the statement. Vertical analysis of an income statement might reflect the total percentage of sales associated with individual corporate divisions or products. Likewise, those items could be shown as a percentage relative to the total costs, or compared to other product costs for the period. Sales are often compared against a benchmark percentage taken from specific industry data, helping to assess organizational performance and compare actual progress with budgeted or anticipated progress. Vertical analysis of the balance sheet would convey items in terms of their percentage of total assets or total liabilities. This information is often used to compare organizational performance to industry averages and against anticipated goals. Managers and/or analysts also use vertical analysis to construct common-size financial statements, standardizing the financial information by giving it a common base or common perspective. Common size statements provide the user with a greater understanding of relationships among the many different elements of the financial statement such as sales and expenses, assets and equities, or cash flows and changes in cash, further facilitating wise decisions as all dependent factors are considered

. This method compares several items to one certain item in the same accounting period. Users often expand upon vertical analysis by comparing the analyses of several periods to one another. This can reveal trends that may be helpful in decision making. An explanation of Vertical analysis of the income statement and vertical analysis of the balance sheet follows.