Comparison of Vertical and Horizontal Analysis
Overview
Very often it can be considered as an unnecessary step. However, it is advisable to carry out vertical and horizontal analysis of financial statements at the initial stage of the economic analysis of the enterprise. The vertical analysis makes it possible to single out, taking into account the industry specifics, the assets components and sources of funds that are most important for a given enterprise, and the horizontal analysis reveals the most significant changes in the structure of assets and directions of financing that took place during the period under the consideration.
The management and investors typically do horizontal and vertical analysis to visualize the changes that have occurred in the main items of the financial reports. Such analysis also helps managers make decisions about how to proceed with their business activities and investors whether a particular business is a good investment option.
The degree of details presented in the financial statement is determined by the goals that are set by the analyst. Sometimes, it is more convenient to carry out vertical and horizontal analysis of a short report, that is, some items can be consolidated. In cases where it is important to determine the significance of individual items of the particular report, the analysis should be carried out more thoroughly.
Vertical Analysis
The vertical analysis gives an idea of the structure of enterprise funds and their sources, expressed not in absolute units, but as percentages. This method consists in the fact that the total amount of the assets of the enterprise (when analyzing the Balance sheet) and revenue (when analyzing the Profit statement) are taken as one hundred percent, and each item of the financial report is computed as a percentage of this base value.
Facebook Inc.
Income Statement
All numbers in millions
Dec 31, 2019
Dec 31, 2018
Dec 31, 2019
Dec 31, 2018
Revenue
$70,697
$55,838
100.0%
100.0%
Cost of revenue
(12,770)
(9,355)
-18.1%
-16.8%
Gross profit
57,927
46,483
81.9%
83.2%
Research and development
(13,600)
(10,273)
-19.2%
-18.4%
Marketing and sales
(9,876)
(7,846)
-14.0%
-14.1%
General and administrative
(10,465)
(3,451)
-14.8%
-6.2%
Income from operations
23,986
24,913
33.9%
44.6%
Interest income
924
661
1.3%
1.2%
Interest expense
(20)
(9)
0.0%
0.0%
Foreign currency exchange losses, net
(105)
(213)
-0.1%
-0.4%
Other
27
9
0.0%
0.0%
Interest and other income (expense), net
826
448
1.2%
0.8%
Above, you can see a vertical analysis of Facebook’s Income Statement completed for two years. You can, of course, prepare vertical analysis for just one year, but a two-year is a much more useful format for the analysis. To prepare this report, you would need to divide all the items by the Revenue amount.
Horizontal Analysis
Horizontal or trend analysis of the financial data compiled in reports provides a different view of the same data. In order to do this type of analysis, you need to choose a base year. For our example, we will use the year 2017 as the base year. The calculation of the percentages necessary for the vertical and horizontal analysis is slightly different. For horizontal analysis, you first need to find the difference between the amount recorded for the same item for the base year and the comparison year. Then, you would divide this difference by the item’s amount for the base year.
For instance, if you have a revenue of $55,838 for the year 2018 and revenue of $40,653 for the year 2017, you would subtract $40,653 from $55,838 to get $15,185. Next, you need to divide this amount by $40,653 to get 37.35%. You will repeat this calculation for all the remaining values, making a calculation for each item horizontally across the years. For the Year 2017, the percentage for all items would be 100% because it is our base year.
Facebook Inc.
Income Statement
All numbers in millions
Dec 31, 2019
Dec 31, 2018
Dec 31, 2017
Dec 31, 2019
Dec 31, 2018
Revenue
70,697
55,838
40,653
74%
37%
Cost of revenue
(12,770)
(9,355)
(5,454)
134%
72%
Gross profit
57,927
46,483
35,199
65%
32%
Research and development
(13,600)
(10,273)
(7,754)
75%
32%
Marketing and sales
(9,876)
(7,846)
(4,725)
109%
66%
General and administrative
(10,465)
(3,451)
(2,517)
316%
37%
Income from operations
23,986
24,913
20,203
19%
23%
Interest income
924
661
398
132%
66%
Interest expense
(20)
(9)
(6)
233%
50%
Foreign currency exchange losses, net
(105)
(213)
(6)
1650%
3450%
Other
27
9
5
440%
80%
Interest and other income (expense), net
826
448
391
111%
15%
Income before provision for income taxes
24,812
25,361
20,594
20%
23%
Provision for income taxes
(6,327)
(3,249)
(4,660)
36%
-30%
Net income
18,485
22,112
15,934
16%
39%