When performing a horizontal analysis, I compare financial data over several periods. This helps me identify trends and patterns in the company's performance. I usually start by selecting a base year and then calculating the percentage change in each line item for subsequent years. For example, if a company's revenue increased by 10% from year one to year two, I would note this as a positive change in the horizontal analysis.
On the other hand, vertical analysis involves comparing each line item on a financial statement to a specific base number within the same period. For the income statement, this base number is usually total revenue, while on the balance sheet, it's typically total assets. I express each line item as a percentage of the base number, which allows me to understand the proportionate contributions of each component. This helps me identify any potential inefficiencies or areas that need improvement in the company's operations.
For instance, if cost of goods sold represents 60% of total revenue, I might investigate further to see if there are any opportunities to reduce this percentage and improve the company's profitability.
By combining horizontal and vertical analysis, I can gain a comprehensive understanding of a company's financial performance and identify potential areas for improvement.