Do you ever wonder how your company’s financial health stacks up to that of competitors? Or how your revenue and expenses have changed over time? If so, you can use horizontal and vertical variance analysis to transform your financial information into a percentage format. This way, you can easily spot trends in year-over-year results and compare your company to industry averages.
Variance analysis may sound complicated but it’s actually fairly straightforward to set up. If you have access to your accounting software, start by downloading two years’ worth of financial statements and copying the information into a spreadsheet.
Horizontal Variance Analysis
Horizontal variance analysis, also known as trend analysis, compares financial statement information over time. Most trend analysis spreadsheets show both the change in the dollar figure and the year-over-year percent change.
To analyze your financials using the horizontal method, place the two years’ worth of data side by side. Subtract this year’s numbers from last year’s numbers to find the dollar amount difference between the two. Divide the dollar amount difference by last year’s numbers to find the percent change. The comparison for the balance sheet should look something like this. The income statement comparison should look like this. You can also do a month-over-month comparison, but seasonal revenue fluctuations can skew the figures.
Look For Unexpected Trends
Once you set up the comparison, note the changes and evaluate how they stack up with your expectations. Keep an eye out for large variations in dollar amounts and percentages, both positive and negative. Pay attention to any changes that are greater than 10 percent. If certain expenses are increasing or revenues are decreasing and you don’t know why, that’s a sign there may be a problem you need to investigate.
Vertical Variance Analysis
Vertical variance analysis of the income statement is the practice of expressing every expense as a percentage of net sales. Vertical analysis of the balance sheet uses the same concept, but every line item is expressed as a percentage of total assets. Expressing the income statement and balance sheet in this way is referred to as generating common-size financial statements. This NetMBA article provides a good example of what a common-size income statement and balance sheet look like.
Compare to Industry Averages
Putting your financial statements in a common-size format makes it much easier to compare your business’ financial performance to that of others in your industry. You’re unlikely to get your hands on competitors’ financial statements unless they’re publicly traded. There are, however, services that collect and report on average expense ratios by industry, which can be compared with the data on your common-size income statement. In an Entrepreneur.com article on analyzing business expenses, former CFO Joe Worth mentions that ProfitCents by Sageworks is a viable source of industry information. However, he also points out that access can be expensive. Rather than purchase a subscription yourself, reach out to your CPA or an accounting firm you’ve used in the past. These resources may be able to get you the information you’re looking for at a lower price.