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Vertical Analysis and Horizontal Analysis

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Source: Instrumental “Drops of H2O ( The Filtered Water Treatment )" by J.Lang (feat. Airtone),” Creative Commons, http://ccmixter.org/files/djlang59/37792

Hey everyone, and welcome to our video today on vertical analysis and horizontal analysis. So what is today's video about? Well, we're going to talk about vertical analysis. And we're going to talk about horizontal analysis. And we're going to walk through performing both of these, so we're going to look at performing vertical analysis and performing horizontal analysis.

Let's start with our vertical analysis. What is vertical analysis? It evaluates financial statement items as a percent of a base amount. So vertical analysis, we're expressing financial statement items as a percent of a base amount.

And now we're analyzing the relationship of each item on the financial statements to some base amount. So for the balance sheet will be looking and expressing each item as a percentage of total assets. And for the income statement will be expressing each item as a percent of net revenue.

And we use vertical analysis to evaluate how the percentages change over time. We can look at changes within the company. We can compare our company to others. And then we can look at industry standard.

So if we look at changes within the company, that's internal. So that's evaluating ourselves internally. And then if we compare ourselves to other companies and against industry standards, that's doing external analysis. OK. So now what we're going to do is we're going to look at an example of how we perform vertical analysis.

OK, everyone. So what we're looking at here is vertical analysis. So we're going to start with vertical analysis of our income statement. So again, vertical analysis is where we express these values as a percentage of a base amount.

And so the base amount is going to be our net sales. So we have two years here to compare. And now what we're going to do is we're going to express all of these line items, so our sales returns and allowances, sales discounts, all of our operating expenses, as a percentage of our base amount, which again for the income statement is going to be our net sales.

So if we go ahead and do that and drop those figures in, if we look at this percentage column, you'll see here our base amount is our net sales. So that represents 100%. And then we're expressing all of these individual line items as a percentage of that base amount so that we can understand the relationship between these specific line items and that base amount.

So for example, just looking here at 2011, our salaries expense was 25.9% of our net sales. And then it looks like in 2012 that went down slightly so then it was 25.4% of our net sales. So not only can we look at the relationship within one year, but we can also look at that changing relationship over time.

OK. So now continuing with vertical analysis, we can do the same thing that we just did for the income statement for the balance sheet. So what we're going to do is express all of these individual line items of our balance sheet as a percentage of our base amount, which for the balance sheet is going to be our total assets. So if we express all of those financial statement line items as a percentage of our total assets, we can understand the relationship between these individual lines and our base amount.

So we can see here things like so our inventory represents 21% of our total assets, or that our notes payable represents 38% of our total assets. And then if we look at the next year, we'll see that that notes payable only represents 34%. So that composition is changing. So again, it helps us to understand the relationship of these individual line items to our base amount.

Great. So now that we've seen how to perform vertical analysis, let's turn our attention to horizontal analysis. What is horizontal analysis? It evaluates percentage changes in financial statements from one period to another, so percentage changes.

So now we're looking at the percentage changes within these individual financial statement items across periods. So it helps us to analyze changes from one period to another. Now not only can we express it in percentages, but we can also express these changes in dollars. So we can look at the percentage change of each line item. And then we can also look at the dollar change of each of those financial statement items.

And again, it helps us to evaluate those changes, any changes within the company, again internal so we can do internal evaluations of how we're structured, what's going on. And then we can do company comparisons. So we can compare ourselves to competitors, as well as compare ourselves against industry standards. So we can do both internal and external comparisons.

So let's look at an example of performing horizontal analysis. OK. So now we're going to look at our horizontal analysis, which is going to help us to look at these individual financial statement lines and how those are changing from one period to the next. So we're focusing in on the individual line items and the changes within those line items themselves.

So the first thing we can do is express those changes in dollar amounts so we can see what the dollar increase or what the dollar decrease is in these individual financial statement lines. And then we can convert that to a percentage, so what is the percentage increase or decrease of these individual financial statement lines? So then we can understand how these are changing over time.

So things like our sales, our sales increased 10% from 2011 to 2012. And then it looks like our rent expense went up 20%. So it helps us to understand the changes that are taking place at the individual financial statement line item.

So now we can perform the same horizontal analysis, but for our balance sheet. So again, what we're going to be looking at is changes in these individual financial statement line items from one period to the next. So the first thing that we do is express the change in dollar amounts.

So we look at the dollar change in this case from 2011 to 2012. So cash increased $10,000. Notes payable went down $25,000. So we can look at the dollar change. So from a dollar perspective, how are these individual financial statement line items changing?

And then we can convert that to a percentage to help us increase our understanding of what's happening and what's going on and what changes are taking place. So we'll see here things like supplies, our supplies went up 20%. Our unearned revenues also going up 33%. Our sales tax payable is going up 10%, which if we think back to our income statement, that makes sense because our sales were increasing.

Great. So now that we've seen how to perform horizontal analysis, let's go ahead and summarize what we talked about today. In a nutshell, today was all about analysis. We looked at vertical analysis. It evaluates financial statement items as a percent of a base amount.

And then we looked at performing horizontal analysis. So that evaluates percentage changes in financial statement items from one period to another. And we looked at examples of both of those.

I hope that everybody enjoyed this video. And I hope to see you next time.

**Vertical Analysis**

*Evaluates financial statement items as a percent of a base amount.*

**Horizontal Analysis**

*Evaluates percentage changes in financial statement items from one period to another.*