When you want to analyze bank financial statements, it’s important to go beyond just reading the numbers. Two essential techniques that provide powerful insights into a bank’s performance are horizontal analysis and vertical analysis. Both methods help investors, analysts, and business owners understand financial trends, efficiency, and stability, but they approach the data differently.
This guide explains how to use horizontal and vertical analysis to evaluate bank financial statements effectively.
What is Horizontal Analysis?
Horizontal analysis compares financial statement data over multiple periods to identify trends, growth patterns, and changes in key metrics. It’s also called trend analysis.
Purpose:
- Detect growth in assets, liabilities, revenue, and profits
- Identify sudden changes in performance
- Evaluate long-term sustainability
How it works:
- Calculate the change in each line item over time (e.g., year-over-year)
- Express the change as a percentage of the previous period
Example:
If a bank’s loans increased from $1,000 million to $1,200 million in one year:
- Change = $1,200M – $1,000M = $200M
- Percentage Change = ($200M ÷ $1,000M) × 100 = 20%
This shows that the bank’s lending grew 20% over the year, providing insights into expansion trends.
Benefits for banks:
- Track loan and deposit growth over years
- Monitor trends in non-performing assets (NPAs)
- Analyze profitability trends through net interest income and net profit
What is Vertical Analysis?
Vertical analysis evaluates each item on a financial statement as a percentage of a base figure for the same period. This approach highlights the relative proportion of items to the total, making it easier to compare across periods or banks.
Purpose:
- Understand the composition of assets, liabilities, and income
- Evaluate operational efficiency and cost structure
- Compare banks of different sizes on a common scale
How it works:
- For the balance sheet: Each asset, liability, and equity item is expressed as a percentage of total assets.
- For the income statement: Each revenue and expense item is expressed as a percentage of total income.
Example:
If a bank’s total assets are $5,000 million and loans account for $3,000 million:
- Loans ÷ Total Assets × 100 = 3,000 ÷ 5,000 × 100 = 60%
This indicates that 60% of the bank’s assets are in loans.
Benefits for banks:
- Evaluate reliance on loans vs. investments
- Assess proportion of operating expenses to revenue
- Compare financial structure with peers regardless of bank size
How Horizontal and Vertical Analysis Complement Each Other
While both techniques are valuable individually, using them together provides a more comprehensive understanding:
- Horizontal analysis: Shows trends over time, such as increasing NPAs or net interest margins.
- Vertical analysis: Reveals structural proportions, like whether a bank is heavily dependent on interest income or fees.
Example:
- Horizontal analysis shows that loans increased 20% year-over-year.
- Vertical analysis shows that loans make up 60% of total assets.
Together, these insights help assess both growth trends and structural balance.
Step-by-Step Guide to Applying Both Analyses
- Collect Financial Statements: Gather at least 3–5 years of balance sheets and income statements.
- Perform Horizontal Analysis: Calculate year-over-year changes for key line items and ratios.
- Perform Vertical Analysis: Express each item as a percentage of total assets (balance sheet) or total income (income statement).
- Compare Trends and Structures: Identify growth areas, cost inefficiencies, or risk concentrations.
- Benchmark Against Peers: Use both analyses to compare similar banks, regardless of size.
Key Metrics to Focus On
When analyzing banks, pay attention to:
- Assets: Loans, investments, cash reserves
- Liabilities: Deposits and borrowings
- Equity: Share capital and retained earnings
- Income: Interest income, non-interest income, net interest margin
- Risk Indicators: NPAs, provision coverage ratio, capital adequacy ratio
Both horizontal and vertical analysis can be applied to these metrics to detect performance trends and structural issues.
Common Mistakes to Avoid
- Ignoring multi-year trends and focusing on a single year
- Overlooking the proportion of expenses relative to income
- Comparing banks without adjusting for size or market segment
- Failing to link trend analysis with structural insights
By avoiding these mistakes, your analysis will be more accurate and actionable.
Final Thoughts
The AI Pathway: Taking Inequity Out of The Credit Equation, combining horizontal and vertical analysis is essential. Horizontal analysis helps track trends and growth over time, while vertical analysis highlights the financial structure and relative proportions of assets, liabilities, and income. Using both techniques together allows investors, analysts, and business owners to gain a clear, data-driven understanding of a bank’s performance, efficiency, and risk profile.
This approach not only reveals past and present performance but also supports smarter financial decisions and long-term planning.
