G1 - Financial Analysis for Credit CH1 Vertical & Horizontal Analysis

Vertical and Horizontal Analysis

What is vertical analysis?

compares line items as a percentage of a base figure (e.g., revenue on the income statement; total assets on the balance sheet).

What is horizontal (trend) analysis?

Comparing line items across periods to spot trends and growth rates.

Why do credit analysts combine vertical and horizontal analysis?

Vertical gives proportions; horizontal shows direction — together reveal structural changes and trends.

What’s a typical base used in vertical analysis of the income statement?

Total revenue (sales).

What’s a typical base used in vertical analysis of the balance sheet?

Total assets.

How does vertical analysis help with profitability?

By converting expenses to % of revenue, it shows margin structure (gross, operating, net).

Over how many years is horizontal analysis best performed?

At least 3 years (more is better) to see meaningful trends.

What’s a simple formula for year-over-year horizontal change?

(Current year − Prior year) ÷ Prior year.

Name three uses of trend analysis.

Forecasting, risk detection, management performance assessment.

What would a declining gross margin but stable net margin suggest?

Management may be cutting fixed costs or improving operating efficiency.

What’s the first step in financial ratio analysis?

Decide purpose (valuation, credit decision, benchmarking) and select relevant ratios.

Which statements provide inputs for ratio analysis?

Income statement, balance sheet, cash flow statement.

What are the two broad ratio groups?

Performance (profitability/efficiency) and Financial (liquidity/leverage/coverage).

How is gross profit margin calculated?

Gross profit ÷ Revenue.

How is operating profit margin (EBIT margin) calculated?

EBIT ÷ Revenue.

How is EBITDA margin calculated?

EBITDA ÷ Revenue.

Why is EBITDA used by credit analysts?

Proxy for operating cash flow that normalises across capital structures and tax regimes.

How is net profit margin calculated?

Net income ÷ Revenue.

Why be cautious comparing net margins across countries?

Tax rates and accounting treatments vary.

What does upward trend in EBITDA margin indicate?

Improved core operating profitability or cost control.

What is benchmark/peer analysis for ratios?

Comparing a company’s ratios to industry peers or internal/proprietary thresholds.

Name two external benchmarking sources.

IBISWorld, CapitalIQ.

What’s the value of using internal portfolio comparables?

Tailored, institution-specific insights and historical default benchmarks.

What is “elevator analysis” and why is it insufficient alone?

Quick snapshot check; insufficient because it lacks depth and causes.

How does vertical analysis help in setting internal risk thresholds?

Percentages reveal whether line items exceed expected ranges tied to risk ratings.

What is the role of ratio adjustments for distortion?

To remove one-offs or non-recurring items for a truer operational view.

Give an example of a distortion to adjust for.

Large one-off gain from sale of asset.

Why check both absolute numbers and ratios?

Ratios hide scale; absolute values reveal magnitude of exposure.

What critical question should one ask after noticing a trend?

“Why is it happening?” — push for root cause.

Should you accept management’s initial explanation for a trend?

No — verify with data, notes, and independent sources.

What is the benefit of comparing ratio trends to macro trends?

Determines if change is company-specific or industry/systemic.

How do you treat seasonal businesses in horizontal analysis?

Use comparable periods (QoQ or YoY same quarter) and seasonal adjustments.

What’s an early-warning sign in horizontal analysis?

Rising receivable days or falling operating cash flow vs net income.

How to use vertical analysis to review cost structure?

Express SG&A and COGS as % of revenue to spot shifts in fixed vs variable costs.

Why is industry context critical when benchmarking margins?

Different industries have inherently different margin profiles.

How can vertical analysis reveal leverage risks?

If interest expense as % of revenue rises, leverage or funding costs may be increasing.

What should you do if ratios differ from industry medians?

Investigate drivers: pricing, costs, mix, one-offs, accounting policy differences.

When is horizontal analysis misleading without vertical analysis?

When growth percentages hide margin erosion or structural shifts.

How do you present findings from vertical/horizontal analysis to management?

Highlight key ratio changes, causes, and corrective actions — be specific and data-backed.

Final quick checklist before completing ratio analysis?

Verify statement consistency, adjust for one-offs, compare to peers, and document assumptions.