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ExamExplained

Horizontal, Vertical and Trend Analysis (SACE Stage 2 Accounting)

Syllabus dot point

“Apply horizontal, vertical and trend analysis to compare financial statements over time and within a period”

6 min read

Quick answer

Horizontal analysis compares the same item across two periods, showing the change in dollars and as a percentage. Vertical analysis expresses each item as a percentage of a base figure within one statement (sales for the income statement, total assets for the balance sheet). Trend analysis indexes several years against a base year set to 100.

Jump to a section
  1. What this dot point is asking
  2. Horizontal analysis
  3. Vertical analysis
  4. Trend analysis
  5. Common-size statements and benchmarking
  6. Linking the three tools to ratios and decisions
  7. Choosing the right tool
  8. Exam-style questions

What this dot point is asking

You need to calculate each type of analysis, present the result clearly, and explain what the comparison reveals about the business.

Horizontal analysis

Horizontal analysis looks across time, measuring how an item moved from one period to the next.

Horizontal analysis

Percentage change=Current year−Base yearBase year×100\text{Percentage change} = \frac{\text{Current year} - \text{Base year}}{\text{Base year}} \times 100

It answers "by how much did this change". A sales rise of $80,000 means more in context once you know it is a 20 percent increase on a $400,000 base.

Vertical analysis

Vertical analysis looks within one statement, expressing each line as a percentage of a base.

Vertical analysis base

In the income statement each item is shown as a percentage of net sales; in the balance sheet each item is shown as a percentage of total assets. This creates common-size statements that allow businesses of different sizes to be compared fairly.

Trend analysis

Trend analysis extends horizontal analysis over several years. The base year is set to an index of 100 and later years are expressed relative to it, so the direction over time is easy to read.

Three kinds of analysis on one business

Income statement extract

Item Year 1 Year 2
Net sales 400,000 480,000
Cost of goods sold 240,000 312,000
Net profit 60,000 62,400
Horizontal (sales)
change =480,000−400,000=80,000= 480{,}000 - 400{,}000 = 80{,}000; percentage =80,000400,000×100=20%= \dfrac{80{,}000}{400{,}000} \times 100 = 20\%.
Vertical (Year 2)
cost of goods sold =312,000480,000×100=65%= \dfrac{312{,}000}{480{,}000} \times 100 = 65\% of sales; net profit =62,400480,000×100=13%= \dfrac{62{,}400}{480{,}000} \times 100 = 13\% of sales. In Year 1, cost of goods sold was 240,000400,000×100=60%\dfrac{240{,}000}{400{,}000} \times 100 = 60\%.
Reading it
sales grew 20 percent, but cost of goods sold rose from 60 to 65 percent of sales, squeezing the gross margin. Net profit grew only slightly because costs grew faster than revenue. Vertical analysis exposes the margin slip that the dollar figures alone hide.
Trend (sales indexed)
with Year 1 as 100, Year 2 is 480,000400,000×100=120\dfrac{480{,}000}{400{,}000} \times 100 = 120.

Common-size statements and benchmarking

Vertical analysis turns each statement into a common-size statement, where every figure is a percentage of a base. This is powerful because it strips out the effect of size: a small cafe and a large restaurant chain can be compared directly when both report cost of goods sold as a percentage of sales. Common-size income statements let you benchmark a business against an industry average or a competitor and ask why, for example, its wages-to-sales percentage is higher than the norm. Common-size balance sheets show the structure of financing and asset use, such as the proportion of total assets held as inventory or funded by liabilities. Benchmarking against an external standard, not just the prior year, is what lifts an answer from describing a change to evaluating performance.

Linking the three tools to ratios and decisions

The three analysis tools are not an end in themselves; they feed the interpretation and decision-making expected in the rest of Topic 2. A horizontal analysis that shows expenses rising faster than revenue flags a falling net profit margin, which the profitability ratios then quantify. A trend analysis of sales indexed over five years, read alongside the inventory turnover trend, can reveal whether growth is being driven by genuine demand or by discounting that erodes margins. When a question asks you to "analyse and interpret", the marks come from moving in this order: calculate the change or structure, identify the likely business cause, and then state the consequence for a named stakeholder such as the owner, a lender or a prospective investor. Presenting the calculation alone, without interpretation, caps the available marks.

Choosing the right tool

Horizontal and trend analysis answer questions about change over time; vertical analysis answers questions about structure within a period. Used together they reveal both the direction and the composition of performance, which is why examiners often ask for more than one in the same question.

Common error

Using the wrong base. The percentage change in horizontal analysis is always divided by the earlier (base) year, not the later year, and vertical analysis on the income statement always uses net sales as the base. Dividing by the wrong figure produces a percentage that looks plausible but answers the wrong question.

Exam-style questions

Questions in the style of SACE Board exam questions on this dot point, each with a worked answer. They are written by ExamExplained unless tagged "Past paper"; the year shows the paper a question is modelled on.

2024 SACE Stage 2-style2 marks
Explain one reason for the significant difference between the inventory turnover for the month of June (calculated earlier) and the inventory turnover for the year 2024 (7.4 times). The trend across years was 2022 9.1 times (40.1 days), 2023 8.6 times (42.2 days), 2024 7.4 times.
Show worked answer →

The two figures are not directly comparable because they cover different lengths of time. A monthly turnover measures cost of goods sold against average inventory for one month, while the annual figure spreads a full year of COGS over average inventory, so the annual figure will normally be much higher (or the monthly much lower) simply due to the period covered.

Within the annual trend, turnover has fallen each year from 9.1 to 8.6 to 7.4 times, meaning stock is taking longer to sell (days rising from 40.1 to 42.2). A valid reason for the slowdown could be a build-up of inventory, slowing demand, or seasonality, where June is a quieter month so a single month gives a distorted picture.

Markers reward recognising the period mismatch (one month versus a full year) as the core reason for the size difference, with a plausible business explanation.

2023 SACE Stage 2-style2 marks
From the comparative income statements for 2023 and 2022, identify the change in any two expenses and state the potential impact on the business for each.
Show worked answer →

This is horizontal analysis: compare each expense across the two years in dollar terms and interpret the change.

Choose any two clear movements, for example:

  • Insurance rose from $4,300 to $20,000 (up $15,700). Potential impact: a sharp increase in fixed costs that eats into profit and squeezes cash flow.
  • Advertising fell from $10,000 to $5,500 (down $4,500). Potential impact: lower promotion may reduce sales and brand awareness, contributing to the fall in revenue.

Other acceptable pairs include interest on mortgage rising (higher borrowing cost) or wages falling slightly (cost control).

Markers reward two correctly identified dollar changes and a sensible business consequence for each, linking the expense movement to profitability, cash flow or future sales.

Practise this

Sources & how we know this

Based on the official SACE Board subject outline. Not yet individually reviewed by a person; always check SACE Board and your school's materials for current rules.

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