Companies carry out budgeting tasks on an ongoing basis in an effort to make the most of available assets and resources. Vertical and horizontal budgeting practices involve two different methods for analyzing a company’s financial statements. These methods allow managers to uncover certain trends within a business’ operations and compare a company’s overall progress with its competitors'.
Company financial statements include a series of items that each relate to different aspects of a business’ revenues and expenses. And while budgeting tasks provide a way for companies to keep track of cash flows, budget-analysis tasks allow managers to uncover relationships between items that would otherwise remain unseen. Information gathered through analysis tasks can also give management a better idea of where a company stands within its industry. Both vertical and horizontal budgeting methods involve converting budget-item dollar amounts into percentages. The two methods differ in terms of the type of base unit used to calculate the percentages.
A vertical budget analysis views a company’s financial statements — such as the income statement and balance sheet — as categories of items. For example, cash, property and equipment would fall under the asset category on a balance sheet. Each category represents a percentage base for the items listed under it. So, total assets would equal 100 percent, and each item amount listed under assets would become a percentage of the total asset amount. In effect, a vertical budget analysis reveals cost and revenues as percentage amounts within each area of a company’s financial activities.
A horizontal budget analysis uses the line items from a past year’s budget as a baseline percentage guideline. The past budget year — also known as the base year — sets the standard for converting line items when analyzing another year’s budget. For example, a company may choose to use its 2009 budget statements as the base year, so line item amounts on a 2011 budget take on percentages based on the amounts contained in the 2009 budget. So, if the total revenue amount comes to $50,000 in 2009 and revenues for 2011 show $25,000, total revenues for 2011 would equal 50 percent. When viewed from this perspective, the horizontal budgeting method reveals increases and decreases for each line item, and also shows any developing trends, such as an increase in revenues coupled with a decrease in inventory costs. Apparent trends may indicate problems or improvements made within different areas of a business operation.
Company Trends vs. Industry Comparisons
Companies wanting to gauge their progress over time may find horizontal budgeting methods more helpful for identifying trends or changes in a company’s financial activities. Since percentage comparisons between base years and current years apply for every line within a financial statement, managers can better spot cause and effect relationships between line items. So, an increase in revenues coupled with a decrease in inventory costs may reveal the profit gains generated through marketing a higher-quality or higher-priced product. Companies interested in comparing their progress with that of industry competitors may benefit from the information provided by a vertical budget analysis. Since vertical budgeting uses a category by category percentage calculation, managers can compare any increases or decreases for individual line items, such as expenses or product sales, with industry averages. This type of comparison can help managers gauge a company’s position or competitiveness within the marketplace.