It’s used in the review at a company financial statement over multiple periods it’s usually depicted as percentage growth over the same line items from the base year. Horizontal analysis horizontal analysis formula allows financial statements used to easily spot trends and growth patterns. The image below shows the comparative income statements and balance sheets for the past two years.
Horizontal analysis is a financial analysis technique used to evaluate a company’s performance over time. 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. Investors can use horizontal analysis to determine the trends in a company’s financial position and performance over time to determine whether they want to invest in that company. However, investors should combine horizontal analysis with vertical analysis and other techniques to get a true picture of a company’s financial health and trajectory. Although a change in accounting policy or the occurrence of a one-time event can impact horizontal analysis, these situations should also be disclosed in the footnotes to the financial statements, in keeping with the principle of consistency. 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.
An alternative format is to simply add as many years as will fit on the page, without showing a variance, so that you can see general changes by account over multiple years. A third format is to include a vertical analysis of each year in the report, so that each year shows expenses as a percentage of the total revenue in that year. Horizontal analysis is one of the most fundamental financial analyses that you can perform. It allows you to compare different data sets over a specific period to identify trends and patterns.
Here net income has decreased by $2,750 or 12% in year 3 when compared to year 1. In this first example, I will be doing a horizontal analysis of Company A’s revenue based on its annual income statement. For example, the vertical analysis of an income statement results in every income statement amount being restated as a percent of net sales. If a company’s net sales were $2 million, they will be presented as 100% ($2 million divided by $2 million). If the cost of goods sold amount is $1 million, it will be presented as 50% ($1 million divided by sales of $2 million). First, a direction comparison simply looks at the results from one period and comparing it to another.
Step 3: Identify Trends and Patterns
The same dollar change and percentage change calculations would be used for the income statement line items as well as the balance sheet line items. The figure below shows the complete horizontal analysis of the income statement and balance sheet for Mistborn Trading. Vertical analysis shows a comparison of a line item within a statement to another line item within that same statement. This allows a company to see what percentage of cash (the comparison line item) makes up total assets (the other line item) during the period. This can help a business to know how much of one item is contributing to overall operations. For example, a company may want to know how much inventory contributes to total assets.
Horizontal analysis compares amount balances and ratios over a different time period. The analysis computes the percentage changes in each income statement amount at the far right. Depending on their expectations, Mistborn Trading could make decisions to alter operations to produce expected outcomes.
How Horizontal Analysis Works
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. Last, a horizontal analysis can encompass calculating percentage changes from one period to the next. As a company grows, it often becomes more difficult to sustain the same rate of growth, even if the company grows in pure dollar size.
Now that you have the percentage change values for your chosen variables – both for your company and others in the same industry – it’s time to analyze your company’s values and those of your competitors. This will allow you to interpret these results within as comprehensive a context as possible. First, decide which periods you will be comparing, carefully choosing comparable periods. For example, if your industry is seasonal, comparing consecutive quarters would provide misleading results. 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.
In conclusion, we’re able to compare the year-over-year (YoY) performance of our company from 2020 to 2021. As in the prior step, we must calculate the dollar value of the year-over-year (YoY) variance and then divide the difference by the base year metric. The latter two tend to go hand-in-hand because the most useful benchmark against which to compare recent performance is most often the preceding period. The findings of common size analysis as compiled in the preliminary stages of due diligence are critical. Horizontal analysis is most useful when an entity has been established, has strong record-keeping capabilities, and has traceable bits of historical information that can be dug into for more information as needed. This type of analysis is more specific relevant for analyzing the value we maybe selling or acquiring.