What are common-size statements and how do vertical and horizontal analysis differ in practice?

Question

AcadiFi · Accepted Answer

Common-size analysis is a powerful tool that standardizes financial statements to enable comparison across time periods (horizontal) and across companies of different sizes (vertical).

**Vertical Analysis (Common-Size):**
Express each line item as a percentage of a base:
- **Income Statement:** Each item as % of Revenue
- **Balance Sheet:** Each item as % of Total Assets

**Horizontal Analysis (Trend):**
Express each line item relative to a base year (or calculate year-over-year growth rates).

**Worked Example: Ashford Consumer Products**

**Income Statement — Vertical Analysis:**

| Item | 2025 ($M) | % Revenue | 2024 ($M) | % Revenue |
|---|---|---|---|---|
| Revenue | $560 | 100.0% | $480 | 100.0% |
| COGS | $336 | 60.0% | $278 | 57.9% |
| Gross Profit | $224 | 40.0% | $202 | 42.1% |
| SG&A | $106 | 18.9% | $86 | 17.9% |
| EBIT | $118 | 21.1% | $116 | 24.2% |
| Net Income | $78 | 13.9% | $82 | 17.1% |

**Horizontal Analysis (Base Year = 2024):**

| Item | 2024 | 2025 | Growth |
|---|---|---|---|
| Revenue | $480M | $560M | +16.7% |
| COGS | $278M | $336M | +20.9% |
| Gross Profit | $202M | $224M | +10.9% |
| Net Income | $82M | $78M | -4.9% |

**What the Analysis Reveals:**

Vertical analysis shows margin compression: gross margin dropped from 42.1% to 40.0%, and net margin fell from 17.1% to 13.9%. Despite revenue growth, profitability per dollar of sales deteriorated.

Horizontal analysis confirms the problem: COGS grew 20.9% while revenue grew only 16.7%. The cost structure is expanding faster than the top line.

**When to Use Each:**

| Use Case | Vertical | Horizontal |
|---|---|---|
| Compare companies of different sizes | Best choice | Less useful |
| Track trends over time | Useful for margins | Best choice |
| Identify cost structure shifts | Shows ratios | Shows magnitude |
| Cross-industry comparison | Essential | Supplementary |

**Exam Tip:** When a vignette provides multi-year data and asks about trends, use horizontal analysis. When it compares two companies of different sizes, use vertical (common-size) analysis. Many questions combine both.

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What are common-size statements and how do vertical and horizontal analysis differ in practice?

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