It allows you to evaluate how effectively a company is converting its revenue into profits. By examining the changes in profitability over time, you can assess the company’s overall financial health. When Financial Statements are released, it is important to compare numbers from Certified Bookkeeper different periods in order to spot trends and changes over time. This can be useful in checking whether a company is performing well or badly, and identify areas where it may improve. Horizontal analysis is the use of financial information over time to compare specific data between periods to spot trends. This can be useful because it allows you to make comparisons across different sets of numbers.

Why You Can Trust Finance Strategists

“The percentage method enables a 25% increase in the ease of financial comparison across various periods and companies,” according to a study conducted by Kim and Lee in 2018. The income statement displays profitability, expenses, and revenue over a specified time frame. Analysts observe trends in critical accounts, including revenue, cost of goods sold, R&D costs, SG&A expenses, operating income, interest expense, and net profit, through horizontal analysis. Success is typically indicated by increasing revenues and net profit, while challenges are indicated by declines. Whether you’re an individual investor, a portfolio manager, or part of an investment team, horizontal analysis provides valuable insights into a company’s financial health and growth prospects.

Historical Background

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. Liquidity ratios are needed to check if the company is liquid enough to settle its debts and pay back any liabilities. Horizontal analysis makes it easy to detect these changes and compare growth rates and profitability with other companies in the industry. Such analysis provides valuable insights into why any of these line items rose or fell sharply or markedly in year 2, compared to year 1.

There are three main methods used for making comparisons in horizontal analysis – direct comparison, variance analysis, and percentage method. We’re diving into some real-life examples that’ll make horizontal analysis as easy as pie—or at least easier than understanding your phone bill. Percentage changes are a crucial part of horizontal analysis as they reveal the relative magnitude of changes between the base year and the current year. These changes are expressed as percentages, making it easier to assess the significance of the differences.

Top 15 Financial Metrics and KPIs in 2024

• Horizontal analysis is only one technique which can be used to analyze financial information.
• 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.
• In 2020 Smith conducted research that suggests “firms are able to decrease financial discrepancies by up to 22%” by identifying significant absolute changes.
• By systematically calculating the absolute and percentage changes, analysts can derive meaningful insights into the financial trends and performance of a company over time.

Horizontal analysis is the comparison of financial statements and accounting ratios over a number of accounting periods. Horizontal analysis is your go-to method for comparing financial data across multiple periods. It’s like having a time machine for your finances, where you can spot trends, identify anomalies, and essentially read between the lines of those monotonous columns of numbers. Industry benchmarking involves comparing a company’s financial performance to industry peers or standards. It provides context for understanding how a company stacks up against competitors and whether it is outperforming or underperforming in specific areas. Once you have gathered the necessary financial statements, the next step is to calculate the dollar amount changes for key financial metrics between the base year and the current year.

The base year serves as the reference point for comparisons, while the current year represents the year under scrutiny. By comparing the current year’s financial data to that of the base year, you gain insights into changes and trends. Let’s now explore the key concepts that are fundamental to understanding horizontal analysis, which is essential for evaluating a company’s financial performance over time.

What are the Differences Between Horizontal vs Vertical Analysis?

The Direct Comparison Method entails the direct comparison of numbers from one accounting period to those from another. The balance sheet displays the assets, liabilities, and equity of a company at a specific point in time. The horizontal analysis of the balance sheet examines changes in accounts such as cash, accounts receivable, inventory, fixed assets, accounts payable, and long-term debt.

Horizontal analysis is often referred to as trend analysis, but the latter term has broader applications and is not specific to financial statements. As the name suggests, trend analysis involves identifying trends and predicting outcomes, which requires analyzing data from multiple consecutive periods. In this article, you will learn about the horizontal analysis of financial statements and how to incorporate it into your company’s accounting practices. You will also learn how to do horizontal analysis using an income statement and a balance sheet. 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.

Analyzing operating cash flow trends over time can reveal how effectively the company manages its day-to-day cash flow and whether it is self-sustaining. In this second example, I will do a horizontal analysis of Company B’s current assets based on the annual balance sheets. The two examples below show how to do horizontal analysis using Google Sheets, but you can easily do the same in Excel. The first example is based on a balance sheet, and the second is on an income statement. Select the base and comparison periods and the values for your chosen variable, then calculate the percentage change between them.

Understanding Horizontal Analysis

A company’s financial performance might look good in isolation, but it could still lag behind its competitors or industry standards. To further illustrate the practical application of horizontal analysis, let’s explore a few more examples that showcase its effectiveness in assessing financial performance and identifying trends. However, it is difficult to establish a definitive trend based on only two or three periods of data.

Analysis on the horizontal level allows investors and analysts to examine a firm’s performance over several years and identify trends and growth patterns. This sort of study permits analysts to observe changes in various line items over time and project them into the future. To perform horizontal analysis, you will need to gather financial data for your company over a specific period. This data can be pulled from your company’s financial statements, such as the balance sheet, income statement, and cash flow statement.