A Beginner’s Guide to Horizontal Analysis

In other words, we can calculate how much net income increased or decreased from year 1 to year 3 (or for that matter any year). Here net income has decreased by $2,750 or 12% in year 3 when compared to year 1. In the next section, you have step-by-step instructions on how to do horizontal analysis with examples using a balance sheet and an income statement. 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.

  • The following two examples of vertical analysis use information from an abbreviated income statement and balance sheet.
  • If the change between two dates is an increase from 2009 to 2010, the change is a positive figure.
  • 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.

This may not be enough of a difference to make a change, but if they notice this deviates from industry standards, they may need to make adjustments, such as reducing the amount of cash on hand to reinvest in the business. The figure below shows the common-size calculations on the comparative income statements and comparative balance sheets for Mistborn Trading. The highlighted part of the figure shows the number used as the base to create the common-sizing. Secondly, in the second type of horizontal analysis, we are interested in knowing about the underlying trends in the line items of the income statement. For this, we compare the absolute change ($) and percentage change (%) in all the line items from one period to the other.

Horizontal analysis provides insights into a company’s financial performance and health. By assessing the changes in revenues, expenses, profits, assets, and liabilities, you can gauge the overall financial well-being of the organization. Financial analysis plays a crucial role in assessing the performance and financial health of a company. One essential technique in financial analysis is horizontal analysis, which allows you to analyze and interpret changes in financial statement data over time.

Horizontal Analysis of the Income Statement

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). We’ll start by inputting our historical income statement and balance sheet into an Excel spreadsheet. For example, if a company’s current year (2022) revenue is $50 million in 2022 and its revenue in the base period, 2021, was $40 million, the net difference between the two periods is $10 million. Horizontal analysis is the aggregation of information in the financial statement that may have changed over time. Horizontal analysis is considered the most important financial statement analysis and for the annual reports.

One common method is using an inflation index or Consumer Price Index (CPI) to calculate the inflation-adjusted values. Ensure the accuracy and completeness of the data, as any inaccuracies can affect the analysis results. Compared to horizontal analysis, the changes are not strictly presented as percentages and are also presented as variance (money amount). Another way to see this is where the base period was unusually poor, taking the year 2020 which was greatly affected by the COVID pandemic for example. What this means is that even with good intentions, periods that are rather average or even dangerous may appear to be great periods and a company does not get the most accurate idea of its financial health and environment.

Horizontal analysis, also known as trend analysis, involves the comparison of financial statement data across multiple periods to identify trends, patterns, and changes. By examining year-to-year changes in key financial metrics, you can gain insights into a company’s growth, stability, and overall performance. This means Mistborn Trading saw an increase of $20,000 in revenue in the current year as compared to the prior year, which was a 20% increase. 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.

Skills for a Financial Analyst

Operating and administrative expenses also increased slightly and interest expense increased by over 12%. In this discussion and analysis of operations, Safeway’s management noted that the increase was due to a growing trend toward mortgage financing. Using this information, you identify the areas of your business that have seen the most positive changes, what works well for your business, and areas that have experienced negative downturns and need improvement and attention. Rather than comparing revenues from 2019, Horizontal Analysis still compares the revenues of 2020 to 2018 (the base year).

Finish Your Free Account Setup

For example, a business may compare sales from their current year to sales from the prior year. The trending of items on these financial statements can give a business valuable information on overall performance and specific areas for improvement. It is most valuable to do horizontal analysis for information over multiple periods to see how change is occurring for each line item. The year being used for comparison purposes is called the base year (usually the prior period). The year of comparison for horizontal analysis is analysed for dollar and percent changes against the base year. Exhibit 134 provides the information needed to analyze Synotech’s comparative statements of income and retained earnings.

SaaS Profit and Loss Statement

By comparing data sets in this way, you can identify trends and patterns in your business performance. The business will need to determine which line item they are comparing all items to within that statement and then calculate the percentage makeup. These percentages are considered common-size because they make businesses within industry comparable by taking out fluctuations for size. It is typical for an income statement to use revenue (or sales) as the comparison line item. This means revenue will be set at 100% and all other line items within the income statement will represent a percentage of revenue.

Also, when an analysis is presented on a repetitive basis over many reporting periods, any changes in the comparison periods should be disclosed, to make readers aware of the difference. Analyze the financial statements of key competitors to gain a broader understanding of industry dynamics and identify areas for improvement or potential competitive advantages. Trend analysis examines the direction and magnitude of changes in financial metrics over an extended period. It helps identify recurring patterns and assess the long-term performance of the company.

Vertical analysis requires numbers in a financial statement to be restated as percentages of a base dollar amount. For balance sheet analysis, total assets, or total liabilities and equity, are used as the base amounts. When financial statements are converted to percentages, they are called common-size financial statements. The following two examples of vertical analysis use information from an abbreviated income statement and balance sheet. Horizontal analysis (also known as trend analysis) looks at trends over time on various financial statement line items. A business will look at one period (usually a year) and compare it to another period.

This can assist in determining what is a definite pattern and what is a one-time occurrence. However, an extra vertical analysis approach is required for management and innovators to make better-informed judgments. The investor may desire to understand how the firm has altered over time to decide. For example, if that Company XYZ’s net income was $10 million and retained earnings were $50 million at the start of its existence, as depicted by example. Whether you do a horizontal analysis quarterly or yearly, it’s worth the time and effort to perform this calculation regularly.

Horizontal analysis of income statement with Example

On the other hand, horizontal analysis looks at amounts from the financial statements over a horizon of many years. 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. An alternate method of performing horizontal analysis calculations is to simply calculate the percentage change between two years as shown in the following example. When Financial Statements are released, it is important to compare numbers from different periods in order to spot trends and changes over time. This can be useful in checking whether a company is performing well or badly, and identify areas where it may improve.

Utilize financial ratios, such as profitability ratios, liquidity ratios, and solvency ratios, to compare the company’s financial performance with industry benchmarks and competitors. This provides a comprehensive view of the company’s relative strengths and weaknesses. Now look at Columns (11) and (12) to see the vertical analysis that would be performed. Columns bookkeeping 101 (11) and (12) express the dollar amount of each item in Columns (7) and (8) as a percentage of net sales. Even though cost of goods sold increased in 2010, it remained a fairly constant percentage of net sales. The percentage of expenses to net sales decreased somewhat, thus yielding an increase in income before income taxes as a percentage of net sales.

Leave a Reply

Your email address will not be published. Required fields are marked *