Introduction
The analysis of financial documents, such as income statements or balance sheets, allows companies to measure performance. In addition, analysis can be useful in budgeting and strategic planning activities. Certain values represented in financial documents can be used to compare the company’s performance to some of its key competitors’, thus indicating its position in the market. Therefore, financial analysis is a crucial tool that is used by all companies, irrespective of their type and size. Vertical and horizontal analyses are among the most popular approaches to reviewing balance sheets and financial statements.
Horizontal Analysis
Horizontal analysis is often used in accounting, as it enables comparing values over time, thus showing a historical trend (Porter & Norton, 2015). For instance, in a recent annual financial statement, net sales of the company for the past several years will normally be included. Thus, horizontal analysis is useful for the management to track the company’s progress and financial position.
Another possible format of horizontal analysis is to include data from the two most recent statements and to state the variance in a different column (Bragg, 2017). In this way, the variance between the values represents the overall trend, which can be either positive or negative. Overall, the horizontal analysis of income statement is beneficial for many companies, as it allows tracking progress and performance over time. As shown by Szramiak (2017), this can assist the management in determining various patterns and cycles that other types of analysis would not be able to identify.
Vertical Analysis
A vertical analysis is a tool used for comparing values in financial statements or balance sheets. It is considered to be a proportional analysis method, as every value is analyzed in percentage share of other values (Wright, n.d.). For example, different types of current assets, including cash and cash equivalents, inventory, and more, would be represented as a percentage of total assets. As shown by Freedman (2017), such a technique is useful when the analysts need to identify the shares of different components in the key indicators.
Similar to ratio analysis, a vertical analysis can indicate if the share of current assets is too low or if the company is facing debt issues. Thus, where a horizontal analysis shows trends, a vertical analysis is usually used to gain insight into the financial values constituting the balance sheet or financial statement.
Ratio Analysis
Financial ratios are frequently used by companies of different types and sizes, as they allow to view the company’s position and performance in different aspects. Some ratios are designed to compare the company’s performance to its main competitors. For instance, benchmarking is often used to determine the company’s position in the market by comparing financial ratios (Peavler, 2017). In benchmarking, certain financial ratios, such as the gross profit margin, are compared to the ones achieved by the leading companies in the market (Peavler, 2017). Using ratios instead of dollars also allows benchmarking with international companies and obtaining precise information regardless of the changes in currency.
Conclusion
Overall, financial analysis is a crucial component of the firm’s success. It helps managers to identify gaps in productivity or threats that could affect the company’s position in the future. A financial analysis also enables the company to monitor trends in sales, assets, and other financial indicators over time, which helps in tracking its progress and market position. Lastly, using the financial ratio analysis, managers and analysts can analyze the firm in comparison with its competitors or market leaders, which can help the company to grow and develop.
References
Bragg, S. (2017). Horizontal analysis. Web.
Freedman, J. (2017). What are horizontal, vertical & ratio analysis in accounting? Web.
Peavler, R. (2017). Limitations of ratio analysis: Advantages and disadvantages of ratio analysis for business. Web.
Porter, G. A., & Norton, C.L. (2015). Financial accounting (10th ed.). Boston, MA: Cengage Learning.
Szramiak, J. (2017). 2 ways to analyze an income statement. Business Insider. Web.
Wright, T. C. (n.d.). What does vertical analysis of a balance sheet tell about a company? Web.