Horizontal & Vertical Analysis of Financial Statements Simply Explained

Balance Sheets, Profit and Loss Reports, General Ledger, AP/AR’s – there are many names for a company’s financial statements. Regardless of what you call them, it’s the analysis of this data that helps company leaders determine the business-related opportunities and problems that the company faces. At its core, the financial statement is a temperature check of the monetary health of the company, defining whether it is capable of expanding, adding headcount and purchasing new technology, or if the company is stretched too thin, struggling with cash flow and overburdened with debt. Implementing business management dashboards, which are progress reports showing key performance indicators (KPIs) at a glance, has helped financial statements evolve from monthly and quarterly reconciliations to daily reviews.

In order to understand how healthy a company is, whether looking at a quarterly summary or an end of day report, management needs to understand how the bottom line has changed over time, as well as look at the return on investment (ROI) of each service and expense.  These core methods of evaluating financial reports are called “horizontal” and “vertical” analysis.

Horizontal financial data analysis includes viewing business information as it changes by reporting periods. Comparing line items on the financial statement such as cost of goods sold (COGS), advertising expenses, and net income from one quarter to another helps practice managers set goals and define progress. Horizontal analysis can include comparing a month or quarter to the previous (sometimes referred to as month over month/quarter over quarter), or to the same time period of the previous year (which shows year over year growth).

When comparing line items, it is critical to determine whether any specific line items changed significantly. For example, if the COGS rose by 20% last quarter, but revenue during the same time period didn’t increase, the company is not seeing ROI from some expenditure. Similarly, if revenue is increasing, but net profit drops, the company leader must determine what cutbacks are needed. When utilizing a dashboard, these trends can be caught sooner and changes can be made prior to the end of the reporting period, resulting in fewer resources/dollars wasted.

Vertical data analysis, on the other hand,  takes a look at financial statements without regard for time. This means the statement is reviewed in a vacuum, without comparing it to other months or quarters. The goal of the vertical analysis is to find correlations among various line items. Company leaders are looking at channels of revenues and expenses, reviewing information in the forms of ratios, and comparing the ROI of marketing, product sales, and business efficiency.

An example of vertical analysis would be the review of the ratio, total expenses divided by revenue. If in a given month total COGS are $20,000 and total revenue is $100,000, the ratio is 0.20 or 20%. And the corresponding ratio of net profit is 80%. Looking at ratios helps determine the ROI of expenses that produce revenue and overall profitability.

Combining horizontal and vertical analysis enable company leaders to look at the same line items over time to recognize financial trends, while also observing how ratios reveal upward and downward trends in revenue and profitability. While reviewing this data, a business leader can then set goals and milestones for the company to meet. For example, a plastic surgeon might see a 15% increase in his/her COGS after purchasing a new laser, providing a new service and revenue channel. The surgeon would then want to see a correlating revenue increase of 30% to show that the investment in the new machine resulted in an increase in profitability.

Through the analysis of financial statements, owners and managers can to review historical data, and compare it to what is currently happening in the company. With new tools like AtlasKPI’s Management Dashboards, leaders can review financial reports and statements on demand, leveraging the information in order to create forecasts and set goals. Company leaders can then use horizontal and vertical business analysis as tools to help them make adjustments to strategies as changes take place that affects expenses and revenue.

2019-01-09T14:16:53-05:00January 7th, 2019|KPI Library|