Question

Asked Apr 11, 2019

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- Explain horizontal and vertical analysis and when you would use one over the other.

Step 1

While assessing financial performance of a company, we can\\'t just look at the company\\'s financial statements in isolation but compare them with other companies of different sizes within and outside the industry. We must also look at the performance over time and try to project future performance of the company. For doing this, most analysts use horizontal analysis and vertical analysis.

Horizontal analysis (also called trend analysis or time series analysis) is done using a base year and calculationg percentage change for each line item year-on-year for several accounting periods. This helps us see growth trends, cyclicality, changes in inventory, changes in costs and other important line items over time. This lets us compare performance of companies of different sizes.

Vertical analysis (also called common size analysis) represents line items on financial statements in relative terms which make sit easy to compare firms of different sizes. In vertical analysis, Income statement line items are represented as percentage of total revenues/sales while in vertical analysis of balance sheet line items are represented as a percentage of assets.

Step 2

Vertical analysis is mostly used when you want to compare companies of different sizes while horizontal analys...

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