Company Financial Statement Analysis & Interpretation Of Financial Statements

horizontal analysis

Another example is using total sales as the base value and restating each sales category as a percentage of the base value. horizontal analysis can be used in conjunction with both the balance sheet and the income statement. As an example below, comparative balance sheets and income statements for Safeway Stores, Inc. showing dollar and percentage change. There were increases of more than 12% in all categories of property other than transport equipment.

The percentage change cannot be computed if base year figure is zero. The horizontal analysis technique uses a base year and a comparison year to determine a company’s growth. The two analysis are helpful in getting a clear picture of the financial health and performance of the company. Horizontal analysis is one of the foremost techniques in financial management and analysis.

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  • Ever since then, we’ve been tearing up the trails and immersing ourselves in this wonderful hobby of writing about the differences and comparisons.
  • For example, a $1 million increase in General Motors’ cash balance is likely to represent a much smaller percentage increase than a corresponding $1 million increase in American Motors’ cash balance.
  • If owner’s equity is $240,000 it will be shown as 60% ($240,000 divided by $400,000).
  • Therefore, horizontal analysis is extremely useful for businesses to understand how the numbers in their income statement are moving.
  • If you are comparing overhead from each quarter of the year or comparing overhead for quarter 3 of 2017 to Quarter 3 of 2016, then you are performing a horizontal analysis.

If the total sales made in 2017 were $30 million and in 2018, they were $28.5 million. Horizontal analysis is useful because it helps a company identify trends and predict future performance. The above is done on balance sheets, retained earnings statements, fixed assets and income statements, and each line within these are considered separately as a percentage of the complete statement. But, when talking about the income statement, the vertical analysis indicates the amount as the percentage of gross sales. Here, multiple periods of financial statements are used to evaluate horizontal analysis. It means that the report helps to show the change in amounts of the statement over a period instead of only the current year. The report that provides the change in accounts helps the professionals assess the growth of an item being sold, by comparing the profitability and financial aspects of the report for multiple years.

Horizontal Analysis Trends Percentage

The vertical analysis shows the relative sizes of the accounts present within the financial statement. Horizontal analysis of the balance sheet is also usually in a two-year format, such as the one shown below, with a variance showing the difference between the two years for each line item. An alternative format is to 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 less-used format is to include a vertical analysis of each year in the report, so that each year shows each line item as a percentage of the total assets in that year. Horizontal analysis of the income statement is usually in a two-year format, such as the one shown below, with a variance also shown that states the difference between the two years for each line item.

horizontal analysis

Earnings per share or current ratio, of different accounting periods are also compared. It allows financial statement users to easily spot trends and growth patterns. Horizontal vertical analyzed to a shareholder that if no change occurs into a financial statement of the business they should fix their future and also make more investment for a high gain of profits.

normal balance can only be used when considering an intra-firm wise comparison, while vertical analysis is used when talking about both inter-firm and intra-firm. By setting a poor performance year as the base year, the comparative performance of other years can be artificially heightened which can mislead stakeholders. A Vertical Analysis can be completed on both an Income Statement and a Balance Sheet.

Business Checking Accounts

Analysts can choose a base year with poor performance and base the analysis on it. This way the current accounting period can be made to appear relatively better. Absolute comparison is when you compare the amount of the same line of the item to its amounts in the other accounting periods. For example, comparing accounts receivables of one year to year before it. 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. This analysis helped companies to fix their goals and also helpful for the shareholders to highlight the weakness of the business programs and to find the way for their improvement.

While horizontal analysis is useful in income statements, balance sheets, and retained earnings statements, vertical analysis is useful in the analysis of income tax, sales figures and operating costs. Horizontal analysis is used to indicate changes in financial performance between two comparable financial quarters including quarters, months or years. On the other hand, vertical analysis is used in the comparison of a financial item as a percentage of the base figure, commonly total liabilities and assets.

horizontal analysis

Looking at and comparing the financial performance of your business from period to period can help you spot positive trends, such as an increase in sales, as well as red flags that need to be addressed. Also referred to as trend analysis, this is the comparison of financial information such as net income or cost of goods sold between two financial quarters including quarters, months or years. Often expressed in percentages or monetary terms, it provides insights into factors that significantly affect the profitability of an organization.

Horizontal Analysis Drawbacks

In horizontal analysis, the earliest period being analyzed is referred to as the base period. As the name implies, this technique is useful for analyzing trends in financial statements. Usually, the changes noted will be depicted both in dollar values and as percentages. Horizontal and vertical analysis of financial statements deal strictly with the time period in question for analyzing the statements.

Ever since then, we’ve been tearing up the trails and immersing ourselves in this wonderful hobby of writing about the differences and comparisons. We’ve learned from on-the-ground experience about these terms specially the product comparisons. This website uses cookies to improve your experience while you navigate through the website. Out of these cookies, the cookies that are categorized as necessary are stored on your browser as they are essential for the working of basic functionalities of the website. We also use third-party cookies that help us analyze and understand how you use this website. These cookies will be stored in your browser only with your consent. But opting out of some of these cookies may have an effect on your browsing experience.

Comparative Income Statement With Horizontal Analysis:

Typically, financial analysts perform horizontal analysis before vertical analysis, and it is usually the most useful for companies that have been operating for a long period of time. Through horizontal analysis of financial statements, you would be able to see two actual data for consecutive years and would be able to compare each and every item. And on the basis of that, you can forecast the future and understand the trend. Horizontal analysis sometimes referred to as trend analysis, is used to identify trends over a particular number of accounting periods. The value of horizontal analysis enables analysts to assess the company’s past performance and current financial position or growth and project the useful insights gained into the future.

Therefore, financial analysis can contribute heavily to a company’s overall success. For instance, if management establishes the revenue increase or decrease in the cost of goods sold is the reason for rising earnings per share, the horizontal analysis can confirm. With metrics like the cash flow to debt ratio, coverage ratios, interest coverage ratio, and other financial ratios, the horizontal analysis can determine whether sufficient liquidity can service the company.

Comparing Vertical Analysis And Horizontal Analysis

To illustrate Online Accounting, let’s assume that a base year is five years earlier. All of the amounts on the balance sheets and the income statements will be expressed as a percentage of the base year amounts. The amounts from five years earlier are presented as 100% or simply 100. The amounts from the most recent years will be divided by the base year amounts. For instance, if a most recent year amount was three times as large as the base year, the most recent year will be presented as 300. If the previous year’s amount was twice the amount of the base year, it will be presented as 200.

This gives an understanding of how certain elements of the financial worksheet have changed over time. Horizontal Analysis refers to the process of comparing the line of items over the period, in the comparative financial statement, to track the overall trend and performance. In vertical analysis, the line of items on a balance sheet can be expressed as a proportion or percentage of total assets, liabilities or equity. In this form of financial statement analysis, financial data of a single accounting period is compared with other financial data of the same entity of the same accounting period. For vertical analysis, a base line item in the financial statements is chosen and all other line items are expressed in percentage terms relative to the selected base item. If a company’s inventory is $100,000 and its total assets are $400,000 the inventory will be expressed as 25% ($100,000 divided by $400,000).

Horizontal Or Trend Analysis Of Financial Statements

However, it excludes all the indirect expenses incurred by the company. First, we need to take the previous year as the base year and last year as the comparison year. For example, let’s say we are comparing between 2015 and 2016; we will take 2015 as the base year and 2016 as the comparison year. By comparing historical financial information you can easily determine your growth and position compared to your competitors. From that comparative statement, you highlight increases or decreases within that time frame.

A manager, on the other hand, is concerned with the day-to-day operations of the company, so he uses this evaluation technique to pinpoint areas for improvement. 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.

Author: Jody Linick