Horizontal Analysis of Financial Statements Overview & Examples

22.2.2021

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. For example, the vertical analysis of an income statement results in every income statement amount being restated as a percent of net sales.

  • In this first example, I will be doing a horizontal analysis of Company A’s revenue based on its annual income statement.
  • This type of analysis is more specific relevant for analyzing the value we maybe selling or acquiring.
  • A company’s financial performance over the years is assessed and changes in different line items and ratios are analyzed.
  • A fundamental part of financial statement analysis is comparing a company’s results to its performance in the past and to the average industry benchmark set by comparable peers in the same (or adjacent) industry.

It helps you understand how your company is performing over time to make more informed decisions about allocating your resources. By comparing data sets side-by-side, you can identify upward or downward trends in revenue, expenses, and net sales. This information can be used to make strategic decisions about pricing, budgeting, and product development. For example, let’s take the case of the income statement – if the gross profit in year 1 was US$40,000 and in year 2 the gross profit was US$44,000, the difference between the two is $4,000. For instance, instead of creating a balance sheet or income statement for one specific period of time, you would also create a comparative income statement or balance sheet that covers quarterly or annual activity for your business.

Horizontal Analysis of the Balance Sheet

There were rises of more than 12% in all categories of property other than transport equipment. Either the data of the rest of the years is expressed as a percentage of the base year or an absolute comparison is performed. If inflation has influenced the financial data, it is essential to adjust the figures to account for its impact.

  • With horizontal analysis, you easily compare the financial position and performance of your company from one period to the next.
  • By analyzing financial statements, your company accurately spots trends over time and identifies the mix of assets and liabilities it has to deal with within a certain period.
  • Fortunately, tools like Google Sheets or Excel allow you to set up templates, so you can forget about the calculations and focus on analysis.
  • After squaring the differences and adding them up, then dividing by the total number of items, we find that the variance is $5,633,400.
  • It’s often used when analyzing the income statement, balance sheet, and cash flow statement.

From a general view, it could be seen that the company made considerable growth in its income between the years. The percentage representation makes it easier to determine the level of change between these different periods. For example, you can use vertical analysis to compare a company’s net income from last year to its net income from this year as a percentage of revenue.

Analyzing Year-to-Year Changes

For example, you might compare a company’s revenue from last year to its revenue from this year or its net income from last year to its net income from this year. For example, you can compare your company’s revenue from last year to this year or your company’s net income from last year to this year. You can also compare specific expenses, such as marketing expenses or wages and salaries.

Look for major fluctuations that may indicate critical events or shifts in the company’s operations. Nonetheless, vertical analysis possesses its own advantages in your company’s accounting operations. The final step involves you reviewing these changes and making appropriate use of the information you get from your analysis.

Consistency in Financial Reporting

For demonstration purposes, the percentages have been rounded to the nearest whole number. Companies may choose to make a period of very poor financial performance the base period and compare all other financial periods with it. This way, companies willfully maneuver and change their growth and profitability trends to their advantage. This makes it easy to see how your company performs over time and identify trends or patterns.

Suppose we’re tasked with performing horizontal analysis on a company’s financial performance from fiscal years ending 2020 to 2021. These and similar questions call attention to areas that require further study. One item of note becomes more what is a unicorn business and how to create one apparent as a result of the trend analysis above. Initially, it was stated that operating expenses were increasing between 2019 and 2021. Based on trend analysis, however, these expenses are actually declining as a percentage of sales.

How to perform Horizontal Analysis?

Trend analysis is the evaluation of financial performance based on a restatement of financial statement dollar amounts to percentages. A company’s financial performance over the years is assessed and changes in different line items and ratios are analyzed. Further analysis via horizontal analysis will likely be required to unlock those insights, and make use of them in a strategic way. You can use horizontal analysis to examine (for example) your company’s profit margins over time, and create strategic spend projections to match projected revenue growth or hedge against seasonality or increased cost of materials. A horizontal analysis is most useful when the underlying financial information is consistently reported, based on the applicable financial reporting framework. Examples of these frameworks are generally accepted accounting principles and international financial reporting standards.

The term “Horizontal Analysis” refers to the method of analyzing financial statements where historical data from the income statement, balance sheet, and cash flow statement are subject to comparison. This comparison shows how each line item has changed in absolute terms or as a percentage change year over year (Y-o-Y). 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.

All these are taken into account in relation to identifying your past financial performance and your prospects for the future. Also, trends are identified to define the actual performance of the company in relation to its first accounting year and how it is predicted to fare as time passes. Other financial statements are also considered during Horizontal Analysis but these two statements are generally sufficient enough to provide appropriate insights into a company’s financial health. Depending on their expectations, Mistborn Trading could make decisions to alter operations to produce expected outcomes. For example, MT saw a 50% accounts receivable increase from the prior year to the current year.

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.

What Is the Difference Between Horizontal Analysis and Vertical Analysis?

In this case, if management compares direct sales between 2007 and 2006 (the base year), it is clear that there is an increase of 3.2%. 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. 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. 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.

In addition, the use of horizontal analysis makes it easier to project trends into the future. Yet another advantage of this form of data presentation is when trends can be compared to those of competitors or industry averages, to see how well an organization’s performance compares with that of other entities. From the horizontal analysis, we observe that Company C has experienced consistent growth in total assets over the four-year period. The growth rates of 10%, 9.09%, and 8.33% indicate a positive trend in the company’s asset accumulation.