Chapter 17, Problem 1DQ

To determine

Explain the differences between horizontal and vertical analysis.

Explanation of Solution

Horizontal Analysis: Horizontal analysis is prepared to make comparison between the financial statements to determine the changes in the financial statements for the previous year to the current year. The changes of the company are measured in dollars as well as in percentage.

Formula: $\text{Percentage Change}=100\times \frac{\text{Later Period}\text{Amount}-\text{Base}\text{Period Amount}}{\text{Base Period Amount}}$

Vertical Analysis: Vertical analysis is prepared to analyze the relationship among various financial statements with a particular base amount. Use the following formula to calculate vertical analysis percentage:

Formula: $\text{Vertical analysis percentage }=\left(\frac{\text{Specific item}}{\text{Base}\text{amount}}\right)\times 100$

This analysis is otherwise called as common-size statement.

Differences between horizontal analysis and vertical analysis

Basis of difference	Horizontal analysis	Vertical analysis
Difference	Horizontal analysis is prepared to make comparison between the financial statements to determine the changes in the financial statements for the previous year to the current year.	Vertical analysis is prepared to analyze the relationship among various financial statements with a particular base amount.
Purpose	This analysis helps the user to compare line by line items and changes happened over the time.	This analysis helps to make comparison of changes occurred in terms of percentage.
Usefulness	This analysis is used to compare the performance with previous years.	This analysis is used to compare company’s performance with other companies.

Conclusion

Thus, the above are the differences between horizontal and vertical analysis.