What is a horizontal analysis of financial statements?

What is a horizontal analysis of financial statements?

First, we need to take the previous year as the base year and last year as the comparison year. If you purchased several fixed assets during 2018, the increase is easily explained, but if you didn’t, this would need to be researched. Perform analysis on the result regardless of it showing a positive or negative outcome on why that happened. Once the result is out showing either the increase of decrease, find out why the result is so. Harold Averkamp has worked as a university accounting instructor, accountant, and consultant for more than 25 years. Revenues increased by 33.17% and Operating Income more than doubled to 116.72% of last year’s value. Elisabeth has a Bachelor of Arts degree from Pace University in New York City.

Vertical analysis expresses each line item on a company’s financial statements as a percentage of a base figure, whereas horizontal analysis is more about measuring the percentage change over a specified period. Consistency is important when performing horizontal analysis of financial statements. When the same accounting standards are used over the years, the financial statements of the company are easier to compare and trends are easily analyzed. Depending on the metrics you want to focus on, you will need different financial statements, like balance sheets, income statements, or cash-flow statements.

Comparative schedule of current assets:

The technique shows whether or not the company is expanding and appreciating in terms of value. Therefore, an investor can easily track a company’s earnings per share ratio, using this analysis balance sheet before making an investment decision. If the analysis shows constant growth year after another, it means that there is a positive trend. So, any investor would most likely prefer to invest in the company and vise versa. When it comes to management, it is mostly concerned with the company’s daily operations. So, it may want to use this technical analysis to point out areas that need improvement and that which it should maintain.

We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy. Whether you do a horizontal analysis quarterly or yearly, it’s worth the time and effort to perform this calculation regularly. The following query features a combination of horizontal analysis and vertical recursion. Trends in gross margin generally reveal how much pricing power a company has. Calculate the percentage change by dividing the absolute change by amount of base year and multiplying the result by 100. Let us understand this analysis with the help of the following balance sheet.

Comparative Balance Sheets With Horizontal Analysis

First, we have Colgate’s income statement’s YoY growth rates from 2008 until 2015. Then, we calculate the growth rate of each of the line items concerning the previous year. Trends or changes are measured by comparing the current year’s values against those of the base year.

By calculating the difference and converting to percentages, we can quickly create a thumbnail snapshot of revenue growth or contraction. First, we noted that Colgate horizontal analysis had not provided segmental information in the income statement. However, as additional information, Colgate has provided some details of segments on page 87.

Analysis and Interpretation of Financial Statements

For instance, some industries are under constant threat of technological disruption, whereas others have far less exposure. The generation of long-term, sustainable profits is a function of possessing an “economic moat”, which, to reiterate, is context-specific because no two industries are identical . By looking at the numbers provided by a company, you should see whether there are any large differences between one year and the next. It is also possible to perform this analysis with time series data to make direct comparisons with other companies.

Studying the percentages in Column could lead to several other observations. For instance, the 6.9 per cent decrease in long-term debt indicates that interest charges will be lower in the future, having a positive effect on future net income.

Examples of horizontal analysis

The changes may be expressed in absolute amounts or percentages (Smart, Megginson, & Gitman, 2007). The data may be presented for two years or for a number of successive years so as to examine the trend. Vertical analysis shows a comparison of a line item within a statement to another line item within that same statement. For example, a business may compare cash to total assets in the current year. This allows a business to see what percentage of cash makes up total assets during the period. Vertical analysis compares line items within a statement in the current year. This can help a business to know how much of one item is contributing to overall operations.

For example, if your industry is seasonal, comparing consecutive quarters would provide misleading results. It would make more sense to compare the values for a specific quarter to the same quarter from past years. If you happen to choose a particularly bad time period for your base values, the values for your comparison period may look much better than they are. Select the base and comparison periods and the values for your chosen variable, then calculate the percentage change between them. Calculating this involves subtracting the base period’s value from the comparison period‘s value, dividing the result by the base period’s value, then multiplying by 100. So, for example, when analyzing an income statement, the first line item, sales, will be established as the base value (100%), and all other account balances below it will be expressed as a percentage of that number.

horizontal analysis definition

Finally, this technique involves preparation of Comparative Balance Sheet and Comparative Income Statement so as to highlight the changes in the various assets, liabilities, income and expenditure. In the Comparative Balance Sheet, the figures of assets and liabilities are set out as at the beginning and at the June of the year along with the extent of increases or decreases between the two dates. These give the analyst insight into how much the line-item value has changed from the base period to the period being analyzed. Solvency Ratios – Just as the name implies, these ratios reveal how solvent a company is, most specifically, how capable of paying its long-term debts. Horizontal analysis should therefore be used in conjunction with other analytical tools like vertical (common-size) analysis and financial ratios to get a more comprehensive picture of the situation at hand and its likely trajectory.

• The percentage change can then be calculated by dividing the dollar change over the base year amount and multiplying the result by 100.
• Horizontal analysis allows financial statement users to easily spot trends and growth patterns.
• However, the same results may be below par when the base year is changed to the same quarter for the previous year.
• An investor can see if a business is expanding and becoming more valuable or becoming less efficient and less valuable.
• Fortunately, tools like Google Sheets or Excel allow you to set up templates, so you can forget about the calculations and focus on analysis.

Also known as trend analysis, this method is used to analyze financial trends that occur across multiple accounting periods over time—usually by the quarter or year. It’s often used when analyzing the income statement, balance sheet, and cash flow statement. Generally, horizontal analysis work is to calculate the percentage changes and amount in financial figures from one year to the other. The objective for comparing is to determine the change in financial figures and the direction of those particular changes in any given company. The analysis is commonly used by internal company management and investors. Individuals who want to invest in a certain firm have to make up their minds on whether to sell their current shares or buy more. When it comes to management, it identifies which moves to make so that it can improve its company’s future performance.