Horizontal Analysis: How to Analyze Financial Statements

Here net income has decreased by $2,750 or 12% in year 3 when compared to year 1. Vertical analysis serves as a more feasible technique compared to horizontal analysis. It is also useful for inter-firm or inter-departmental performance comparisons as one can see relative proportions of account balances, regardless of the size of the business or department. As seen from the above example, every ratio is given in relation to the revenue in the case of income statement.

Direct Comparison

For example, the cash balance at the end of one accounting period can be compared to other accounting periods. In horizontal analysis, the changes in specific items in financial statements i.e. net debt on the balance sheet or revenue on the income statement– are expressed as a percentage and in a specific currency – for example, the U.S. dollar. Another method of horizontal analysis is calculating the variance between multiple financial items in multiple financial statements and spanning multiple accounting periods. Trend Analysis is a technique used to identify trends spanning different accounting periods by highlighting the changes in different financial statements when comparing items to each other. Horizontal analysis typically shows the changes from the base period in dollar and percentage. For example, a statement that says revenues have increased by accounting 10% this past quarter is based on horizontal analysis.

What Is the Difference Between Horizontal Analysis and Vertical Analysis?

• Horizontal analysis provides insights into a company’s financial performance and health.
• This enables managers to investigate the variances and ascertain their causes, whether they are positive or negative.
• Using consistent accounting principles like GAAP ensures consistency and the ability to accurately review a company’s financial statements over time.
• Horizontal analysis, also known as trend analysis, involves the comparison of financial statement data across multiple periods to identify trends, patterns, and changes.
• It helps identify recurring patterns and assess the long-term performance of the company.

Since we do not have any further information about the segments, we will project the future sales of Colgate based on this available data. Nonetheless, vertical analysis possesses its own advantages in your company’s accounting operations. The percentage change approach is where the full force of the horizontal analysis formula comes in and changes are fully represented in percentage. By dividing the net difference by the base figure, the percentage change comes out to 25%. Mike Dion is https://www.bookstime.com/articles/tax-filings a seasoned financial leader with over a decade of experience transforming numbers into actionable strategies that drive success.

• It is also possible to perform this analysis with time series data to make direct comparisons with other companies.
• Sometimes you may find horizontal analysis reports, saving you the calculations, but you can always calculate the percentage change yourself using publicly available financial data.
• By comparing prior-period financial results with more current financial results, a company is better able to spot the direction of change in account balances and the magnitude in which that change has occurred.
• Horizontal analysis, or “time series analysis”, is oriented around identifying trends and patterns in the revenue growth profile, profit margins, and/or cyclicality (or seasonality) over a predetermined period.
• By following these steps, you’ll transform those intimidating columns of numbers into actionable insights.
• It means the changes are shown as a percentage of a base item in the statement and there are no representations for variance.

Example 1: Revenue Analysis for Company A

Success is typically indicated by increasing revenues and net profit, while challenges are indicated by declines. 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. Analysts are interested in assets that are utilised efficiently and have balances that are consistent with sales levels. The research determined that horizontal analysis offers substantial insights into financial trends, which facilitates the development of more informed strategic decisions. Additionally, the investigation demonstrated that organisations that implemented this approach experienced a 15% decrease in unforeseen financial discrepancies, which improved their overall financial stability and stakeholder confidence.

• First, decide which periods you will be comparing, carefully choosing comparable periods.
• The two examples below show how to do horizontal analysis using Google Sheets, but you can easily do the same in Excel.
• Look for significant variations, both positive and negative, and identify any trends or patterns that emerge.
• The profit before tax marginally declined by 0.3% from Rs 98,438 million in 2023 to Rs 98,147 million in 2024.

Would you prefer to work with a financial professional remotely or in-person?

This method can be applied to assess a company’s financial standing and assist investors in making defensible investment choices. Investors can discover potential risks and opportunities that could affect a company’s future financial performance by comparing financial data from one period to the next. As explained in Jones’ 2022 research published in the Journal of Financial Analysis, horizontal analysis formula over 80% of companies rely on these methods to gain insights into trends and growth from period to period. Horizontal analysis focuses on comparing absolute amounts and percentages across different time periods, typically over the course of years. This highlights increases or decreases in accounts on the financial statements.

• The primary difference between vertical analysis and horizontal analysis is that vertical analysis is focused on the relationships between the numbers in a single reporting period, or one moment in time.
• Using Layer, you can also automate data flows and user management, so you can gather the data automatically, carry out the analysis, and automatically share results and reports with the right users.
• This could also be due to poor marketing or excess inventory due to seasonal demand.
• This type of analysis is also very useful if an investor wants to determine the performance of a company prior to investing in the same.
• 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.
• Remember to consider industry benchmarks, peer analysis, and best practices to ensure accurate and meaningful results.

All these are taken into account in relation to identifying your past financial performance and your prospects for the future. As business owners, the compilation of financial statements is usually the only measure taken to represent financial health. However, having these statements alone and just looking at the figures does not help you by itself to improve your financial situation.