Sep
6
2012

Horizontal vs Vertical analysis:

stock fundamental analysisWhile analysing the companies fundamentally, two methods are adopted widely. These methods are:

  1. horizontal analysis, and
  2. vertical analysis

of the financial results/numbers. Whenever we analyse a business fundamentally, we try to judge it’s performance in the past and hence extrapolate the futuristic performance. To do this we need some benchmark to look for the growth or contraction in the financial results and the method to create such benchmark or the way to look at the financial numbers create two different approaches.

 

HORIZONTAL ANALYSIS:

This kind of analysis is when we judge the financial data of the present year by using prior years’/quarters’ data as the base figures. That means we will check for the growth or decline in the individual numbers by looking at the figures that were present in the previous year/quarter; depending on whether we are judging year-on-year(represented by y-o-y) growth or quarter-on-quarter (represented by q-o-q) growth. Thus we may call it as a trend analysis.

For an instance look at the following figure that shows the analysis of Cipla via horizontal analysis approach.

 

Income statement:

Fundamental analysis

*Figures presented in INR crores

The calculations have been done as:

Sales turnover % = (7074.73 – 6368.06)/6368.06 * 100

 

Balance sheet:

Fundamental analysis

*Figures presented in INR crores

The calculations have been done as:

Cash and bank balances % = (55.06 – 83.98)/83.98 * 100

 

Application of Horizontal analysis:

This concept is generally applied to help analyst focus on key factors affecting profitability. For an instance in the example showing income statement analysis, an analyst can observe the COGS going down by 2.35% as a positive factor as sales has also increased simultaneously. Thus it provides a much clearer picture of the individual factors.

 

 

VERTICAL ANALYSIS:

Vertical analysis on the other hand presents various financial numbers by comparing them with a fixed number from the same years’/quarters’ data. We find out the relationship within the same periods’ data. Thus vertical analysis is a proportional/compositional analysis of a financial statement.Here each item on the financial statement is represented as a proportion of a fixed item from the same report.

For performing vertical analysis of income statement (or the P/L account) every item is expressed as a percentage of gross sales. For vertical analysis of balance sheet every item is expressed as a percentage of: total assets when calculating assets section, total liabilities when calculating liabilities section and total stockholders’ equity when calculating equity section of the balance sheet.

For an instance check the following example:

 

Income statement:

Let us apply the above concept to the income statement. Here we simply use ‘net sales’ as the reference figure for our calculations.

stock technical analysis

*Figures presented in INR crores

The calculations have been done as:

Other income composition = 148.3/7125.80 *100

 

Balance statement:

For applying the concept of vertical analysis to the balance sheet we use ‘total assets’ as the denominator in the composition calculations; and ‘total of liabilities and equity capital’ for the liabilities section. Let us consider the following example.

stock technical analysis

 *Figures presented in INR crores

The calculations have been done as:

Cash and bank balances composition = 55.06/8993.79 * 100

 

Application of vertical analysis:

Vertical analysis is used mostly in cases to get an awareness of the composition or the relative proportion of account balances. It also finds it’s application for cross checking the performance of a business over a period of time. For an instance if the corresponding proportion of COGS has increased to an alarming level of 70% against an average of 25% observed over several years, then this calls for special attention to be taken.

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