Understanding your startup’s finances through vertical and horizontal analysis

TL;DR

Vertical and horizontal analysis are two complementary tools for reading a financial statement. Vertical (common-size) analysis shows each line item as a percentage of a base figure in the same period, while horizontal (trend) analysis shows the change in a line item across two or more periods.

• Vertical analysis formula: Line item ÷ base figure × 100
• Horizontal analysis formula: (Current period − prior period) ÷ prior period × 100
• Base figure for income statement: Total revenue
• Base figure for balance sheet: Total assets (or total liabilities + equity)

Use both together to understand both where your money goes and how things are changing.

As your startup scales, so will the complexity of your finances. Maybe you’ve taken the plunge and hired your first finance lead, or perhaps you’re doing your best to navigate financial decisions yourself, despite a background in product or sales. Whether you’re hands-on with your finances, or watching an Excel sheet over the shoulder of someone who is, it’s crucial that you understand the basics of your financial picture and have a foundational understanding of how to interpret raw numbers into core takeaways.

Generally, there are two approaches to analyzing financial data: vertical (common-size) analysis and horizontal (trend) analysis. Each has its clear use cases and benefits, and the reality is that you’ll probably find yourself shuffling between both of them to understand your finances on a deeper level.

Vertical analysis (also called “common-size analysis”) involves evaluating each line item on a financial statement as a percentage of a base figure within that same statement. According to Corporate Finance Institute's definition of vertical (common-size analysis), the base figure on an income statement is typically total revenue, while on a balance sheet, it's typically total assets (with liabilities and equity expressed as a percentage of total liabilities + equity).

As an example, let’s say you have a young marketing agency and your quarterly income statement for Q4 looks something like this:

*Cost of Services Sold (COS) is the services equivalent of Cost of Goods Sold (COGS) — the direct costs of delivering the service to customers.

Vertical analysis: step-by-step walkthrough

Let's run a vertical analysis on December 2023 using total revenue ($60,000) as the base.

Step 1 — Set up the spreadsheet. Put your line items in column A, December dollar amounts in column B, and the vertical analysis percentages in column C.

Step 2 — Identify your base figure. Revenue in cell B2 = $60,000. This is your denominator for every calculation in column C.

Step 3 — Calculate each line item as a percentage of revenue. The formula in column C is: =B[row]/B$2

Here's the full December stack:

Step 4 — Interpret the results. COS consuming 80% of revenue means the agency keeps only 20 cents of gross profit on every dollar of revenue before operating expenses hit. Then operating expenses consume another 80% of revenue on top of that, which pushes the agency into a net loss of 60 cents on every dollar of revenue (20% gross profit minus 80% operating expenses = –60% net margin).

What about balance sheet vertical analysis?

The same technique applies to a balance sheet, with total assets as the base figure instead of total revenue. For example, if a company has $500,000 in total assets and $100,000 is cash, cash represents 20% of total assets. As Workday's common-size analysis guide notes, this approach reveals the relative importance of each balance sheet account and is especially useful for comparing companies of different sizes.

When to use income-statement vertical analysis: You're diagnosing cost structure, margin performance, or operating efficiency. Questions like "How much am I spending on marketing relative to revenue?" or "What's my gross margin trend?" live here.

When to use balance-sheet vertical analysis: You're diagnosing capital intensity, liquidity, or runway. Questions like "How much of my assets are tied up in inventory?" or "What percentage of my capital structure is debt?" live here. For startup founders specifically, balance-sheet common-size analysis is useful for understanding how much of your total capital is sitting in liquid cash versus fixed assets, which speaks directly to your runway.

When to rely on vertical analysis

Vertical analysis can provide you with clear and concise insight into the relative proportions of a financial statement. Typically, it's one of the first data points potential investors will want to understand: compared to your base item, how much are you spending on hardware, office space, or data storage?

Vertical analysis is also useful when you want to understand financial performance compared to industry benchmarks. For example, Deloitte's IT spending research shows that average technology spend held near 5% of revenue across industries, though SaaS and software-heavy businesses often run materially higher. If a young marketing agency found that its total software spend was running at 25% of revenue, that would be worth investigating; not necessarily a problem, but worth understanding.

Vertical analysis is especially useful during early-stage planning, as you budget and start laying out your financial forecasts. But you'll come back to it often — it's crucial for understanding the cost structure and resource allocation during a given time period, especially as you consider big purchases, new hires, and other costs (and revenues) that come with scaling a business.

Vertical analysis is useful regardless of the stage of your company. For earlier-stage companies, it can help you understand how various expense items and your cash burn/profitability compare to your revenues. If the resulting ratio percentages are very high, it can be a good signal that your costs are scaling too quickly relative to how your revenue is growing.

For later-stage companies, investors will often want to see improvements in operating leverage over time, meaning those ratio percentages decline over time to show that revenue is growing faster than expenses. They’ll also benchmark you against similar competitors in your industry to understand how efficient you may be relative to others. Again, there very well may be reasons why your ratios are different but being armed with the vertical analysis helps equip you to better tell your company’s story.

How to interpret your findings:

• If operating expenses exceed 70–80% of revenue for multiple months, audit your largest expense line items and identify the top 2–3 drivers. In our example, marketing spend at 33% of revenue is worth looking into further — have the campaigns generated a good enough return?
• If gross margin (20% in our example) is below industry benchmarks, dig into COS: are vendor rates competitive, is there scope creep in client deliverables, or is pricing too low?
• If one line item balloons as a percentage of revenue, there should be an explanation why. Is the increase in cost meant to be an investment for the future?

Where vertical analysis falls short

While vertical analysis is effective for cross-sectional analysis, it might not always tell the full story, especially when you're making comparisons over time. This isn't necessarily a bad thing, but make sure you're filling in context with qualitative data before jumping to conclusions. A large marketing line item might look concerning as a percentage of revenue, but if that spend drove the customer acquisition that built your next six months of recurring revenue, the percentage alone isn't the full story. Know your line items in comparison to your base, and know how to compare them to industry benchmarks — but don't jump to the conclusion that you're doing something wrong just because you're out of line with an industry benchmark.

Horizontal analysis — also called trend analysis — involves comparing financial data across time periods to identify trends and patterns. Corporate Finance Institute defines horizontal analysis as an approach used to analyze financial statements by comparing specific financial information for a certain accounting period with information from other periods, which helps analysts understand the direction in which financial metrics are moving over time.

Horizontal analysis: step-by-step walkthrough

Using the same dataset, let's compare November to December 2023.

• Step 1 — Set up the spreadsheet. Put line items in column A, November amounts in column B, December amounts in column C, absolute change in column D, and percentage change in column E.
• Step 2 — Calculate absolute change. Column D formula: =C[row]-B[row]
• Step 3 — Calculate percentage change. Column E formula: =(C[row]-B[row])/ABS(B[row])
• Note: the ABS() function around the denominator is important when working with negative values (like net income) so that your workbook doesn’t misread the direction of change.

Step 4 — Run the numbers for each line item:

Step 5 — Interpret the results.

• Revenue up 20%, COS up 23%: COS grew faster than revenue, so gross margin compressed month over month. Only 20 cents of every new revenue dollar converted to gross profit.
• Operating expenses down 17%: This is a great signal for improved efficiency. Most of this came from marketing dropping from $30k to $20k.
• Net income improved by 23% (losses shrunk from –$47k to –$36k). For negative-to-less-negative comparisons, it's clearest to describe it as an "improvement" rather than a "23% increase," which could suggest the loss got larger.

When to rely on horizontal analysis

Rely on horizontal analysis for regular financial health checks over time, and to understand how factors (both inputs and outputs) are changing as your business scales. Also use horizontal analysis to understand and communicate trends (both good and bad) with investors.

Horizontal analysis enables you to detect trends and patterns, which is a great way to both understand what's working and catch issues before they spiral out of control. In our marketing agency example, horizontal analysis shows that revenue increased by 20% between November and December while COS increased 23%. The cost-to-revenue ratio worsened slightly between the two months. But operating expenses decreased significantly due to lower marketing spend, suggesting the agency is growing more efficiently.

How to interpret your findings:

• If COS grows faster than revenue for two consecutive months, audit vendor rates and contractor scope. Either costs are creeping up, or pricing hasn't kept pace with the inputs.
• If operating expenses decline as a percentage of revenue while revenue grows, that's operating leverage — worth highlighting in investor updates. 
• If net loss narrows month over month, quantify how much of the improvement is due to efficiency versus one-time spending decrease (e.g., a pause in marketing spend that can't be sustained).

Where horizontal analysis falls short

While trend analysis is important, horizontal analysis doesn’t provide sufficient context for understanding the underlying cause of trends. External factors like changes in the market, economic conditions, and industry trends can all impact the results of horizontal analysis, and founders should be cautious to take these factors into account before assuming internal factors are the cause for changes over time.

Use vertical analysis when:

• You're preparing investor materials and need to show the cost structure.
• You're benchmarking against industry peers.
• You're evaluating whether a specific expense category aligns with expectations.
• You're presenting a snapshot of a single period.

Use horizontal analysis when:

• You're running a monthly financial review.
• You're evaluating whether changes are trending positively or negatively.
• You're communicating momentum (or lack of it) to investors.
• You're trying to catch issues before they become emergencies.

Use both when:

• You're making a major strategic decision (new hire, expansion, pricing change).
• You're preparing for a fundraise — investors expect both views.
• You need to explain a change in a single metric by showing both its absolute movement and its relative size.

Horizontal and vertical analysis together tell a full story: context is king, and the most accurate picture of a company’s financial situation can only be understood when both pieces of the puzzle are considered in tandem.  No matter how you cut it, stay close to your data to understand trends, insights, and patterns, but make sure to take a step back sometimes, too: marrying financial analysis with your own observations and knowledge will help you tell the most complete picture as you continue to scale.