Horizontal and vertical revenue analysis methods give analysts and investors a way to assess revenue at a detailed level over several time periods. Each method provides its own insights. The vertical method allows for easier comparison to other companies, while the horizontal method provides information that helps the company plan future-revenue expectations.
Vertical analysis, also known as common-size analysis, is a method that sets every line item of a financial statement as a percent of one number. For example, a common-size income statement calculates every line item as a percentage of total revenues. This method standardizes financial information to allow analysts a useful means for comparing the company to others of different sizes. For example, among manufacturing companies of different sizes, the cost of goods sold as a percent of total revenue should fall within the same percentage range across the group of companies. Differences could mean the subject company has either developed new, efficient methods ahead of its competitors, or it has not adopted the methods of its peers and has lower efficiency.
Analyzing separate revenue streams as a percent of total revenue provides useful information to internal and external analysts and investors. A vertical revenue analysis requires separate revenue streams to be calculated as a percent of total revenues. Companies offering products segregated by groups, product lines, countries or other differentiating factors can gain insight into the company's sales performance and make business decisions appropriately.
Horizontal analysis is less complex than vertical analysis, and involves simply reading revenue results across several time periods. This could be from month to month, quarter to quarter or year to year. Analysts use several periods of horizontal revenue analysis to formulate the basis for future-revenue expectations and growth rates for budgets, forecasts and company-valuation models. Segregating revenue streams by product groups or other characteristics helps isolate strong selling products and weaker products over time.
Horizontal and vertical revenue analyses both offer useful information, but the two methods used together could offer the most insight to analysts and investors. A few years of detailed common-size income statements arranged side-by-side can show whether expenses are growing as a percent of sales over time, and can help the company quickly isolate the worst offenders. Vertical and horizontal analysis used together can also highlight erratic revenue results over time for specific product lines.
