Financial Analysis Methods

Horizontal analysis
This is a financial analysis strategy that is used when analyzing the historical performance of an organization. It compares historical data such as line items or ratios over different accounting periods (Kenton, 2018). Analysis may either apply percentage comparisons where current financial data is computed as a percentage of past performance, or it can involve use of absolute comparisons where actual data is analyzed over similar data in the past to assess historical performance. One of the advantages of horizontal analysis is that it enables the management or investors to understand what drives the performance of the company (Droms & Wright, 2015). They are able to detect growth patterns and trends that may include seasonality. Moreover, through evaluating the balance sheet, income statement and cash flow statements historically, they can develop a whole picture of the results of their operations and whether they operate profitably and efficiently.
Vertical analysis
This is a financial analysis method that lists line items as a percentage of base figures in financial statements (Droms & Wright, 2015). For instance, line items on income statements can be expressed as percentages of the gross sales while those on income statements are expressed as percentages of total liabilities and assets. This form of accounting analysis is usually used when analyzing the financial performance of a company within a single reporting period. One of its advantages is that it is possible to analyze trends when compared between different accounting periods. For instance, if the percentage of cost of goods to sales has always been approximately 40%, then a variation of 50% would reveal changes in trends and the need to investigate the cause of such a variance (Lung, 2017). Vertical analysis is also effective when comparing the performance of two or more companies of different magnitudes. For instance, comparing a \$10 million company with a \$100 million corporation is easier when vertical analysis is used to analyze common sized accounts in both firms. Horizontal analysis is difficult since the huge differences in magnitude of both companies will create disproportional figures that are hard to interpret.
Similarities and differences between the two methods
One of the similarities between both approaches is that they analyze the financial performance of a company. Both forms of analysis have the goal of assessing a corporation’s performance for purposes of decision making by management and other stakeholders (Droms & Wright, 2015). Vertical analysis achieves this goal through analyzing line figures within one historical period while horizontal analysis attains the same objective through comparative assessment of a firm’s performance over multiple financial periods (Lung, 2017). The major difference between both approaches is in how they are computed. Vertical analysis focuses on the same historical period and analyzes line items while horizontal analysis evaluates different accounting items over multiple accounting periods.
How vertical analysis can be applied in the case study
Vertical analysis can be applied to the case study on the Boston Children Hospital. When analyzing the hospital’s balance sheet using this approach, different line items can be compared. For instance, current ratio of the company would be calculated by dividing the current assets with the current liabilities. In this case, the current assets for the year 2013 would be as follows;

Current ratio (2013): 46,394/33,721 = 1.376
For the year 2012, the current ratio would be as follows;
Current ratio (2012): 56,533/34,778 = 1.626

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``The management of the hospital can compare the changes in current ratio between 2012 and 2013 to evaluate whether the institution is able to meet its short term obligations to lenders.  For instance, the reduction in current ratio from 1.626 to 1.376 between 2012 and 2013 may signal that the hospital is taking advantage of short term financing opportunities or it is efficiently using its current assets (Lung, 2017). Moreover, other forms of analysis can be done on the hospital’s balance sheet and some of these include the quick ratio, long term debt/equity ratio, total debt/equity ratio and others. ``

Why the vertical method should be used over the horizontal method
In the case of the Boston hospital, the vertical analysis method should be used over the horizontal analysis method. The first reason is when analyzing the balance sheet, evaluation of line items within the same accounting period will generate ratios that are easily comparable to the hospital’s past performance. It is difficult to use the horizontal method since the balance sheet contains many items such as assets that do not frequently change, and which cannot be used to gauge performance in isolation (Droms & Wright, 2015). Use of the vertical analysis through balance sheet ratios can be comparable to previous years’ performance to ascertain a trend. The Boston Children Hospital should also use the vertical analysis so that it can compare its performance against other hospitals regardless of their size. It is difficult to use horizontal analysis to assess its performance against very large or very small hospitals since the figures presented will be disproportional.

References
Droms, W. G. & Wright, J. O. (2015). Finance and Accounting for nonfinancial Managers:
All the Basics you need to Know. New York: Basic Books,
https://www.investopedia.com/terms/v/vertical_analysis.asp
https://www.investopedia.com/terms/h/horizontalanalysis.asp
Lung, H. (2017). Fundamentals of Financial Accounting. New York: Elsevier.

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