Analysis Problem
Practice Problem: InnovateTech Solutions Inc. Financial Analysis
Here is a practice problem about horizontal and vertical analysis, along with its solution.I
InnovateTech Solutions Inc. has provided its financial statements for the past three years. Your task is to perform both horizontal and vertical analysis on the provided Balance Sheets and Income Statements. Then, briefly interpret one key insight from each type of analysis.
To solve this problem, we will perform horizontal analysis and vertical analysis for both the Balance Sheet and the Income Statement.
Balance Sheet | Year 1 | Year 2 | Year 3 |
| Assets | |||
| Cash | 50 | 65 | 70 |
| Accounts Receivable | 120 | 140 | 160 |
| Inventory | 80 | 90 | 100 |
| Property,Plant, & Equipment | 250 | 280 | 300 |
| Total Assets | 500 | 575 | 630 |
| Liabilities | |||
| Accounts Payable | 70 | 80 | 85 |
| Short Term Debt | 30 | 35 | 40 |
| Long Term Debt | 150 | 160 | 170 |
| Total Liabilities | 500 | 575 | 630 |
| Equity | |||
| Common Stock | 100 | 100 | 100 |
| Retained Earnings | 150 | 200 | 235 |
| Total Equity | 250 | 300 | 335 |
| Total Liabilities & Equity | 500 | 575 | 630 |
Income Statement | Year 1 | Year 2 | Year 3 |
| Revenue | 1000 | 1150 | 1300 |
| Cost Of Goods Sold | 600 | 670 | 750 |
| Gross Profit | 400 | 480 | 550 |
| Operating Expenses | 250 | 280 | 310 |
| Operating Income | 150 | 200 | 240 |
| Interest Expense | 15 | 18 | 20 |
| Earnings Before Tax | 135 | 182 | 220 |
| Income Tax Expense | 30 | 40 | 48 |
| Net Income | 105 | 142 | 172 |
Horizontal Analysis
Horizontal analysis, also known as trend analysis, involves comparing financial statement line items over a period of time to identify trends and growth rates. It expresses the change as a percentage of the base year (the earliest year in the comparison period). This type of analysis helps in understanding the year-over-year growth or decline of specific accounts and overall financial performance.
The formula for horizontal analysis is: Percentage Change = ((Current Year Value - Prior Year Value) / Prior Year Value) x 100%
Vertical Analysis
Vertical analysis, also known as common-size analysis, expresses each financial statement line item as a percentage of a base figure within the same statement. For the Balance Sheet, total assets (or total liabilities and equity) is typically the base. For the Income Statement, total revenue (or sales) is the base] This analysis helps in understanding the proportional composition of the financial statements and how these proportions change over time, allowing for easier comparison across different periods or with industry benchmarks.
The formula for vertical analysis is: Percentage = (Line Item Value / Base Value) x 100%