📚 PASS Research Analyst Certification Examination Difficulty: Beginner ℹ️ Info   ~5 min read
📌 Chapter 8.10 — Financial statement analysis using ratios

Imagine you are analyzing the quarterly filings of an Indian FMCG major. You observe that raw material costs have risen by 500 crore rupees, an absolute figure that appears alarming in isolation. To make sense of this, you must shift your perspective using two fundamental analytical lenses: horizontal and vertical analysis. Without these, your financial model is merely a collection of isolated data points rather than a coherent narrative of corporate health.

Vertical analysis, or common-size analysis, acts as a structural scanner. By expressing every line item in an income statement as a percentage of total revenue, you establish a baseline for efficiency. For instance, if you find that employee benefit expenses have crept from 12% to 15% of revenue over three years, you have successfully isolated a structural shift in the company’s cost base.

This method allows you to compare a small regional player against a giant like HUL, normalizing the disparate scale and revealing true operational differences in their business models.

Horizontal analysis, conversely, serves as your temporal radar. It measures the percentage change of line items across multiple time periods, such as year-on-year or quarter-on-quarter growth. If revenue grew by 10% but interest expenses surged by 40%, horizontal analysis immediately raises a red flag regarding the company’s leverage strategy.

While vertical analysis tells you ‘where the money goes,’ horizontal analysis tells you ‘how the business is trending.’ Using them in tandem allows you to see if a decline in net margins is due to a deliberate investment in market share or an inability to manage rising input costs.

For a research analyst, these tools are indispensable when drafting a valuation report. When you project future earnings, you cannot simply forecast absolute numbers; you must rely on the relationships established by these analyses. If horizontal analysis shows that R&D spending consistently outpaces revenue growth, you must incorporate that trend into your DCF model to maintain credibility. Relying on historical averages without checking for directional trends—horizontal—or structural consistency—vertical—often leads to flawed assumptions and poor investment recommendations.1

Nuance

⚠️ Nuance
A common trap for candidates is confusing the ‘base’ for each analysis. Analysts often mistakenly perform horizontal analysis by comparing items to total revenue, or perform vertical analysis by looking at year-over-year changes. Remember: vertical is always ‘up and down’ the statement against a single base in one period, while horizontal is ’left to right’ across time. Misapplying these leads to skewed growth rates that can make a declining business appear stable.

Check Your Understanding

Practice Question 1

An analyst reviewing a company’s Balance Sheet notices that ‘Inventories’ have grown from 10% to 18% of Total Assets over three years, while revenue has remained flat. Which analytical technique is the analyst primarily using, and what does it suggest?

Practice Question 2

If an analyst is comparing the growth rate of ‘Selling, General, and Administrative’ (SG&A) expenses over the last five years relative to revenue growth, which technique is being employed?

This is a companion read for Section 8.10 — Financial statement analysis using ratios from PASS Research Analyst Certification Examination by Akhilesh Gururani, available on Amazon Kindle.

Copyright © 2026 Akhilesh Gururani. All rights reserved.

  1. Vertical analysis uses a ‘base’ figure (like Revenue for P&L or Total Assets for Balance Sheet) set to 100%, allowing for proportional comparisons across companies of different sizes. Horizontal analysis uses the earliest period as the base year (100%) to calculate subsequent period changes as a percentage of that base. ↩︎