Horizontal Analysis Definition, Formula, Example in Excel
Horizontal analysis involves the calculation of percentage changes from one or more years over the base year dollar amount. The following two examples of horizontal analysis use an abbreviated income statement and balance sheet information where 2019 represents the base year. For demonstration purposes, the percentages have been rounded to the nearest whole number. Consistency is important when performing horizontal analysis of financial statements.
This could prove to be the main factor enabling the company to attain a consistent increase in net income and, therefore, the main point of focus in maintaining it. Another method of horizontal analysis is calculating the variance between multiple financial items in multiple financial statements and spanning multiple accounting periods. Trend Analysis is a technique used to identify trends spanning different accounting periods by highlighting the changes in different financial statements when comparing items to each other. Horizontal Analysis, also known as Trend Analysis, is an analysis technique in accounting used over financial statements such as balance sheets, statements of retained earnings, and income statements, among others.
Key Metrics in Horizontal Analysis
From that comparative statement, you highlight increases or decreases within that time frame. This way, you can quickly see growth, as well as any red flags that require attention. Whether you do a horizontal analysis quarterly or yearly, it’s worth the time and effort to perform this calculation regularly.
- You can choose whatever interval (month-over-month, year-over-year, etc.), but each iterative financial statement should be equal distance away regarding when it was issued compared to other bits of financial information.
- Horizontal analysis is particularly useful for detecting changes in a company’s balance sheet over time.
- You need at least two accounting periods for a valid comparison, but if you want to really spot trends, you should have at least three, if not more accounting periods of data available for calculating horizontal analysis.
- Adding a third year to the analysis will be even more helpful, as you’ll be able to see if there is a definite trend.
- Above, you are presented a comparative retained earning statement for the years 2020 and 2021.
- It would make more sense to compare the values for a specific quarter to the same quarter from past years.
A company that wants to budget properly, control costs, increase revenues, and make long-term expenditure decisions may want to use financial statement analysis to guide future operations. As long as the company understands the limitations of the information provided, financial statement analysis is a good tool to predict growth and company financial strength. When considering the outcomes from analysis, it is important for a company to understand that data produced needs to be compared to others within industry and close competitors. The company should also consider their past experience and how it corresponds to current and future performance expectations. Three common analysis tools are used for decision-making; horizontal analysis, vertical analysis, and financial ratios. With horizontal analysis, you look at changes line-by-line, between specific accounting periods – whether it be monthly, quarterly, or annually.
Example of Comparative Income Statement with Horizontal Analysis
Carrying out horizontal analysis of the income statement and balance sheet helps investors and creditors to determine the current financial position of a company. By looking at past performance, it can help assess growth rates, spot trends (by comparing changes from period to period), generate forecasts, or project the insights gained into the future. Horizontal analysis can help evaluate a company’s financial standing or position vis-à-vis its competitors. Financial statement analysis reviews financial information found on financial statements to make informed decisions about the business.
Horizontal and vertical analysis
You will also learn how to do horizontal analysis using an income statement and a balance sheet. The company will need to determine which line item they are comparing all items to within that statement and then calculate the percentage makeup. It is typical for an income statement to use net sales (or sales) as the comparison line item.
Step 3: Identify Trends and Patterns
Attention must be given to possible economic influences that could skew the numbers being analyzed, such as inflation or a recession. Additionally, the way a company reports information within accounts may change over time. For example, where and https://personal-accounting.org/horizontal-analysis-of-balance-sheets-and/ when certain transactions are recorded may shift, which may not be readily evident in the financial statements. Many companies do not split credit and cash sales, in which case net sales would be used to compute accounts receivable turnover.
Problems with Horizontal Analysis
With the financial information in hand, it’s time to decide how to analyze the information. As in the prior step, we must calculate the dollar value of the year-over-year (YoY) variance and then divide the difference by the base year metric. Per usual, the importance of completing sufficient industry research cannot be overstated here.
Secondly, in the second type of horizontal analysis, we are interested in knowing about the underlying trends in the line items of the income statement. For this, we compare the absolute change ($) and percentage change (%) in all the line items from one period to the other. One should ideally take three or more accounting periods/years to identify trends and how a company is performing from one year/accounting period to the next year/accounting period. Your financial statements, including your balance sheet, income statement, and cash flow statement provide operational information and provide a clear picture of performance. These documents can also show a company’s emerging successes and potential weaknesses, based on metrics such as inventory turnover, profit margin, and return on equity. Horizontal analysis allows investors and analysts to see what has been driving a company’s financial performance over several years and to spot trends and growth patterns.