Bookkeeping

Horizontal or Trend Analysis of Financial Statements Explanation and Example

what is a horizontal analysis

Horizontal Analysis → The comparison of a company’s financial data between periods to spot trends , as well as for peer group benchmarking purposes. Thus, companies of different sizes in terms of total revenue and currently at different stages in their lifecycle can still be compared to obtain useful insights. Cost Structure → At the end of the day, the reinvestment needs of a company is directly tied to the industry it operates in. For that reason, the amount of capital needed on hand to fund day-to-day working capital needs and capital expenditures , i.e. the purchase of long-term fixed assets, varies widely across each industry. Long story short, the “common size” financial statements are only informative if the companies being compared as similar in nature, such as the business model, target customer profile, end markets served, etc.

Ratios such as asset turnover, inventory turnover, and receivables turnover are also important because they help analysts to fully gauge the performance of a business. However, the percentage increase in sales was greater than the percentage increase in the cost of sales. For example, in Safeway Stores’ balance sheets, both sales and the cost of sales increased from 2018 to 2019. Several interesting balance sheet changes are apparent in the tables below. There were rises of more than 12% in all categories of property other than transport equipment. Alhtough this comparison is useful on its own, investors and management typically use both horizontal andvertical analysistechnuques before making any decisions. However, for the management and inventors to be able to make better-informed decisions an additional vertical analysis technique is necessary.

Terms Similar to Horizontal Analysis

Harold Averkamp has worked as a university accounting instructor, accountant, and consultant for more than 25 years. The content on finmasters.com is for educational and informational purposes only and should not be construed as professional financial advice. Finmasters is not a financial institution and does not provide any financial products or services. We strive to provide up-to-date information but make no warranties regarding the accuracy of our information.

  • Using consistent accounting principles like GAAP ensures consistency and the ability to accurately review a company’s financial statements over time.
  • The earliest period available in a given data set, i.e. the starting point from which progress is tracked.
  • Since we do not have any further information about the segments, we will project the future sales of Colgate based on this available data.
  • Important information can result from looking at changes in the same financial statement over time, both in terms of dollar amounts and percentage differences.
  • Horizontal analysis improves and enhances the constraints during financial reporting.
  • If they were only expecting a 20% increase, they may need to explore this line item further to determine what caused this difference and how to correct it going forward.

Comparability means that a company’s financial statements can be compared to those of another company in the same industry. An absolute comparison involves comparing the amount of the same line of the item to its amounts in the other accounting periods. For example, comparing the accounts receivables of one year to those of the previous year. The most obvious benefit of horizontal analysis is that helps paint a picture of how a business has performed over time. Trends are used https://www.bookstime.com/ when projecting future performance and analysts use them to identify where they believe the business is within the business cycle. This can happen when the analyst modifies the number of comparison periods used to make the results appear unusually good or bad. For example, the current period’s profits may appear excellent when only compared with those of the previous month, but are actually quite poor when compared to the results for the same month in the preceding year.

How To Create An Agile Finance Function

It can assess whether sufficient liquidity can service the company using indicators such as the cash flow to debt ratio, coverage ratios, interest coverage ratio, and other financial ratios. Horizontal income statement analysis is typically done in a two-year manner, as shown below, with a variance that shows the difference between the two years for each line item. Also, any changes in the comparison periods should be reported when an analysis is presented on a repeating basis over numerous reporting periods so that readers are aware of the difference. When it comes to management, it determines the actions to do in order to improve the future performance of the firm. In general, the method aids in understanding a company’s performance so that educated decisions may be made. Horizontal analysis, also called time series analysis, focuses on trends and changes in numbers over time.

what is a horizontal analysis

This key distinction is oftentimes ignored, which leads to confusion when trying to interpret metrics that are expressed in percentage units across time. Occupancy is one of these metrics, so let’s use it as an example to clarify the issue. Horizontal analysis is performed by comparing financial data from a past statement, such as the income statement.

What is Horizontal Analysis?

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. On the other hand, horizontal analysis looks at amounts from the financial statements over a horizon of many years. All of the amounts on the balance sheets and the income statements for analysis will be expressed as a percentage of the base year amounts. The amounts from three years earlier are presented as 100% or simply 100.

The year of comparison for horizontal analysis is analysed for dollar and percent changes against the base year. Horizontal analysis is the comparison of financial data from one accounting period, usually a recent year, to a base accounting period, usually a prior year, and identifies trends. It can be performed on any financial data that has been recorded over time. To perform a horizontal analysis, first it is necessary to calculate the dollar change from the base period to the target period, which can be as short as a month, or a quarter, or as long as a year. The percentage change can then be calculated by dividing the dollar change over the base year amount and multiplying the result by 100.

Horizontal or trend analysis of financial statements

For example, if management expects a 30% increase in sales revenue but actual increase is only 10%, it needs to be investigated. While the net differential does not provide much practical insights, the fact that the difference is expressed in percentage form facilitates comparisons to the company’s base period and to the performance of its comparable peers. Horizontal Analysis is performed by placing multiple years’ worth of data lined up next to each other and then graphing the data points to determine if there is a horizontal analysis trend, and where it is going. A horizontal analysis of the trends in profitability ratios will reveal if the company is increasing its profitability, remaining stable or decreasing. The fastest way to see trends is to look at the changes from period to period. But, if you need more detailed analysis, you’ll want to view variances – either as percentages or dollar amounts. Horizontal analysis is important because it allows you to compare data between different periods and makes it easier to identify changes in trends.

what is a horizontal analysis

By exploring coverage ratios, interest coverage ratio, and cash flow-to-debt ratio, horizontal analysis can establish whether sufficient liquidity can service a company. Horizontal analysis can also be used to compare growth rates and profitability over a specific period across firms in the same industry. In vertical analysis, the line of items on a balance sheet can be expressed as a proportion or percentage of total assets, liabilities or equity. However, in the case of the income statement, the same may be indicated as a percentage of gross sales, while in cash flow statement, the cash inflows and outflows are denoted as a proportion of total cash inflow. This is because vertical analysis expresses each line in the financial statements as a percentage of a base value, like sales. Using this example, vertical analysis takes the income statement and expresses every line item as a percentage of sales, whereas horizontal analysis is concerned with the percentage change in total sales over a period. Vertical analysis shows a comparison of a line item within a statement to another line item within that same statement.

Types of Analysis

This year, Company ABC reports a net income of $10 million and retained earnings of $27 million. As a result, there’s a $5 million increase in net income and $2 million in retained earnings year over year. You may also opt to calculate income statement ratios like gross margin and profit margin. Ratios such as earnings per share, return on assets, and return on equity are similarly invaluable. These ratios make problems related to the growth and profitability of a company evident and clear.

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