Whether you perform this analysis every fiscal year or every quarter, the information it provides is well worth the time and effort required. Insert a column to the right of ‘2022’ and click on the cell corresponding to the first revenue line item. A horizontal line proceeds from left to right on a chart, or parallel to the x-axis. We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The figures of the various years are compared with standard or base year. The comparison between the two ratios indicates that despite the rise in both revenue and cost of sales, the gross profit has changed only marginally. To perform vertical analysis (common-size analysis), we take each line item and calculate it as a percentage of revenue so that we can come up with “common horizontal analysis size” results for both companies. It’s almost impossible to tell which is growing faster by just looking at the numbers. We can perform horizontal analysis on the income statement by simply taking the percentage change for each line item year-over-year. One reason is that analysts can choose a base year where the company’s performance was poor and base their analysis on it.
WHAT IS HORIZONTAL ANALYSIS?
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. A horizontal analysis is used to see if any numbers are unusually high or low in comparison to the information for bracketing periods, which may then trigger a detailed investigation of the reason for the difference. It can also be used to project the amounts of various line items into the future. In horizontal analysis, we compare the changes in the financial statements over a period of time…. Horizontal analysis typically shows the changes from the base period in dollar and percentage. For example, a statement that says revenues have increased by 10% this past quarter is based on horizontal analysis. The percentage change is calculated by first dividing the dollar change between the comparison year and the base year by the line item value in the base year, then multiplying the quotient by 100.
- We can perform horizontal analysis on the income statement by simply taking the percentage change for each line item year-over-year.
- Let’s assume an investor is looking to invest in Company ABC. The investor wants to determine how the company grew over the past year, to see if his investment decision should provide solid ROI.
- As an investor, you should be digging in to a company’s financial statements.
- For financial analysis, these external parties to the firm depend almost entirely on the published financial statements.
- Drag down the cell with the formula to copy it to the other revenue line items, as well as the total net revenue.
Use it to spot trends in your business.Horizontal analysis, also known as trend analysis, is used to spot financial trends over a specific number of accounting periods. Horizontal analysis can be used with an income statement or a balance sheet. For instance, if management establishes the revenue increase or decrease in the cost of goods sold is the reason for rising earnings per share, the horizontal analysis can confirm. With metrics like the cash flow to debt ratio, coverage ratios, interest coverage ratio, and other financial ratios, the horizontal analysis can determine whether sufficient liquidity can service the company. It can also be used to compare growth rates and profitability over a period of time, across companies in the same industry. To illustrate horizontal analysis, let’s assume that a base year is five years earlier.
Overview: What is horizontal analysis?
Likewise, a high percentage rate indicates the need to improve the use of Assets. Vertical Analysis refers to the analysis of the financial statement in which each item of the statement of a particular financial year is analysed, by comparing it with a common item. Horizontal allows you to detect growth patterns, cyclicality, etc. and to compare these factors among different companies. Horizontal analysis is important because it allows you to compare data between different periods and makes it easier to identify changes in trends. This can be helpful in making decisions about whether to invest in a company or not. You can also use horizontal analysis in conjunction with both the balance sheet and the income statement. This method of analysis makes it easy for the financial statement user to spot patterns and trends over the years.
- The financial statement of two or more periods is used for comparison in the horizontal analysis.
- A less-used format is to include a vertical analysis of each year in the report, so that each year shows each line item as a percentage of the total assets in that year.
- 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.
- The comparability constraint dictates that your statements and documents need to be evaluated against companies similar to yours within the same industry.
How detailed your initial financial statements are depends largely on the accounting software application you’re using. If you’re using an entry-level application, it’s likely you’ll need to use spreadsheets in order to complete the horizontal analysis.
Horizontal analysis vs. vertical analysis: What’s the difference?
Because this analysis tells these business owners where they stand in their financial environment. To conclude, it is always worth performing horizontal analysis, but it should never be relied upon too heavily. Other factors should also be considered, and only then should a decision be made. The investor now needs to make a decision based on their analysis of the figures, as well as a comparison to other similar figures. For example, a low inventory turnover would imply that sales are low, the company is not selling its inventory, and there is a surplus. This could also be due to poor marketing or excess inventory due to seasonal demand. 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.
What does ratio analysis offer that financial statement alone do not offer? Calculate the percentage change by first dividing the dollar change between the comparison year and the base year by the line item value in the base year, then multiplying the quotient by 100. The example from Safeway Stores shows a comparative balance sheet for 2018 and 2019 following a similar format to the income statement above.
Although common size analysis is not as detailed as trend analysis using ratios, it does provide a simple way for financial managers to analyze financial statements. The technique can be used to analyze the three primary financial statements, i.e., balance sheet, income statement, and cash flow statement. In the balance sheet, the common base item to which other line items are expressed is total assets, while in the income statement, it is total revenues. 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. A big problem with this method is that the compilation of financial information may change over time, meaning that elements of the company’s financial statements (expenses, current assets, liabilities, etc.) may change between periods. This results in variations since balances for each period are compared sequentially.
Is horizontal analysis is also known as static analysis?
Horizontal analysis is termed as dynamic analysis. Vertical analysis is done to review and analysis the financial statements for a year only and therefore it is also called static analysis.
Horizontal analysis allows financial statement users to easily spot trends and growth patterns. Using the comparative income statement above, you can see that your net income changed by $1,500 from 2017; a percentage increase of 5.3%, but what really stands out on the income statement is the 266% increase in depreciation expense. For example, some companies may sacrifice margins to gain a large market share, which increases revenues at the expense of profit margins. Such a strategy allows the company to grow faster than comparable companies because they are more preferred by investors. Horizontal analysis, also called time series analysis, focuses on trends and changes in numbers over time. Horizontal allows you to detect growth patterns, cyclicality, etc., and to compare these factors among different companies.
Advantages of Horizontal Analysis
Further, vertical analysis can also be used for the purpose of benchmarking. A horizontal analysis, also referred to as ‘trend analysis’, is a procedure in the financial analysis where the amounts of financial information over a certain period of time is compared line by line in order to make related decisions. Vertical analysis, also called common-size analysis, focuses on the relative size of different line items so that you can easily compare the income statements and balance sheets of different sized companies. With horizontal analysis, you use a line-by-line comparison to the totals. For instance, if you run a comparative income statement for 2019 and 2020, horizontal analysis allows you to compare the revenue totals for both years to see if it increased or decreased, or remained relatively stable. If possible, you should aim to add 2018 to the mix, so you’ll be able to see if it was a trend or just a fluke.