Horizontal Analysis of Financial Statements Overview & Examples

Individuals who want to invest in a certain firm have to make up their minds on whether to sell their current shares or buy more. When it comes to management, it identifies which moves to make so that it can improve its company’s future performance. Generally, the technique helps in understanding the performance of a business to be able to make informed decisions. Comparative income statements with vertical analysis can be compared to give a company an idea of its financial health spanning years. This could prove to be the main factor enabling the company to attain a consistent increase in net income and, therefore, the main point of focus in maintaining it. Horizontal analysis is used in financial statement analysis to compare historical data, such as ratios, or line items, over a number of accounting periods.

• For example, on an income statement each line item will be listed as a percentage of gross sales.
• In addition, for the hospitality industry, Smith Travel Research , CBRE, and HVS all provide various statistics, from operational to financial, for management and owners.
• The final earnings statement from the current time period is called a retained earnings statement.
• Financial analysis of an income statement can reveal that the costs of goods sold are falling, or that sales have been improving, while return on equity is rising.
• On the other hand, comparability constraint dictates that a company’s financial statements and other documentation be such that they can be evaluated against other similar companies within the same industry.
• If you’d rather see both variances and percentages, you can add columns in order to display changes in both.

Adding a third year to the analysis will be even more helpful, as you’ll be able to see if there is a definite trend. Harold Averkamp has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

Drawbacks of Using Horizontal Analysis

DuPont analysis uses several financial ratios that multiplied together equal return on equity, a measure of how much income the firm earns divided by the amount of funds invested . Activity ratios are meant to show how well management is managing the company’s resources. Two common activity ratios are accounts payable turnover and accounts receivable turnover.

This type of analysis is mostly used by investors, financial analysts, and business managers. However, anyone who is interested in the future of a company will be interested in conducting a trend analysis to determine its likely https://www.bookstime.com/ trajectory. This may include creditors, regulatory authorities, and industry observers like business journalists, among others. The trend may be misleading if the wrong set of accounting periods are used to analyze the company.

Change Management

It can be performed on any financial data that has been recorded over time. To perform a horizontal analysis, first it is necessary to calculate the dollar change from the base period to the target period, which can be as short as a month, or a quarter, or as long as a year. The percentage change can then be calculated by dividing the dollar change over the base year amount and multiplying the result by 100. The analysis of critical measures of business performance, such as profit margins, inventory turnover, and return on equity, can detect emerging problems and strengths. For example, earnings per share may have been rising because the cost of goods sold has been falling or because sales have been growing steadily.

• Positive or negative trends are spotted and this method serves as more reliable when presenting external stakeholders like investors and creditors with your company’s financial health.
• Individuals who want to invest in a certain firm have to make up their minds on whether to sell their current shares or buy more.
• Horizontal analysis may be conducted for balance sheet, income statement, schedules of current and fixed assets and statement of retained earnings.
• Horizontal analysis enables investors, analysts, and other stakeholders in the company to see how well the company is performing financially.
• Horizontal analysis of financial statements can be performed for comparing data across multiple quarters in the same year, quarterly analysis on a year-on-year basis, and yearly comparisons.

For example a $1 million increase in sales is much more significant if the prior year’s sales were $2 million than if the prior year’s sales were $20 million. In the first situation, the increase would be 50% that is undoubtedly a significant increase for any firm. In the second situation, the increase would be 5% that is just what is a horizontal analysis a reflection of normal progress. Horizontal Analysis is undertaken to ascertain how the company performed over the years or what is its financial status, as compared to the prior period. As against, vertical analysis is used to report the stakeholder about the portion of line items to the total, in the current financial year.

What is the difference between Horizontal and Vertical Analysis?

For instance, a manager might compare cost of goods sold and profit margin over a two or three-year span to see how efficient the company is becoming. This comparison of income statements will give the manager not only a benchmark for future performance; it will also help him understand what needs to be changed in the future. Since, any line item in a financial statement or financial ratio can be compared across a period of time, it makes the horizontal analysis extremely useful for anyone trying to track a company’s performance over time. For example, a horizontal analysis of the cost of insurance might list the cost on a quarterly basis for the past few years, while a vertical analysis would present it as a percentage of sales only for the current period. Vertical analysis is also known as common size financial statement analysis.

Then, gather financial statements for the current period or any other period for which you want the comparison. In Horizontal Financial Analysis, the comparison is made between an item of financial statement, with that of the base year’s corresponding item. On the other hand, in vertical financial analysis, an item of the financial statement is compared with the common item of the same accounting period. Have you ever been involved in organizing a fundraising campaign year after year?