Data Analysis Part 1: Horizontal Analysis

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. Seeing the horizontal analysis of every item allows you to more easily see the trends. It will be easy to detect that over the years the cost of goods sold has been increasing at a faster pace than the company’s net sales.

Expenses seem to be more aligned with the set’s trend, but with revenues lagging far behind the average, this isn’t very good news either. In the end, compared to your competitors’ 15.3 percent increase, your humble 2.7 percent gain in GOP leaves a bitter aftertaste. Horizontal income statement analysis is typically done in a two-year manner, as shown below, with a variance that shows the difference between the two years for each line item. However, an extra vertical analysis approach is required for management and innovators to make better-informed judgments. Evaluation of an organization’s financial performance over many reporting periods. First, bookkeeping for startups only looks at changes in absolute numbers, without considering the underlying reasons for those changes.

Company Financial Statement Analysis: Spotting Future Trends

When, only a year ago in 2013, Sale Return and Allowances was only 7%, meaning that there is most likely more instances of defective items. Then, consider that in 2014, 50% of Cost of Goods Sold was 50% where it was 55% a year ago. By seeing the trend, which is a remarkable growth of over 100% from one year to the next, we can also see that the trend itself is not that remarkable of only 10% change from 2013 at 110% to 120% in 2014. For example, although interest expense from one year to the next may have increased 100 percent, this might not need further investigation; because the dollar amount of increase is only $1,000. In a Horizontal Analysis, we state both the dollar amount of change and the percentage of change, because either one alone might be misleading.

Once you have calculated the percentage change for each item, you can start to interpret your results. Look for items that have had a large increase or decrease in percentage terms. These items may warrant further investigation to see if they are indicative of trends in the business or if they are one-time events. Second, horizontal analysis can be misleading when comparing companies of different sizes.

Horizontal Analysis vs. Vertical Analysis

Given how 2020 was so widely different from years past, it’s hopefully an outlier for many industries as the global economy begins to recover from the pandemic. For the greatest accuracy, you should ensure all the financial statements are prepared consistently according to the Generally Accepted Accounting Principles (GAAP). The consistency constraint means that you have to use the same accounting methods and principles every year. Note that in this illustration, each line item is shown as a percentage of the total for its category.

Financial analysis is the process of assessing enterprises, projects, budgets, and other financial-related entities in order to identify an organization’s stability, solvency, liquidity, and profitability. Individuals who wish to invest in a company must decide whether to sell their present shares or purchase more. When creating a Vertical Analysis of an Income Statement, the amounts of individual items are calculated as a percentage of Total Sales. To calculate 2014, we DO NOT go back to the baseline to do the calculations; instead, 2013 becomes the new baseline so that we can see percentage growth from year-to-year. No company lives in a bubble, so it is also helpful to compare these results with those of competitors to determine whether the problem is industry-wide, or just within the company itself.

Impact of Reporting Standards on Horizontal Analysis

The restated amounts result in a common-size income statement, since it can be compared to the income statement of a competitor of any size or to the industry’s percentages. 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. A horizontal analysis is an important tool for financial professionals, since it allows them to quickly and easily compare the performance of a company over multiple periods.

In other words, analysts use this type of analysis to compare performance metrics or accounts over a given period. They do this to see whether there is an improvement or a decline as far as the performance of the company is concerned. https://marketresearchtelecast.com/financial-planning-for-startups-how-accounting-services-can-help-new-ventures/292538/ is often referred to as trend analysis, but the latter term has broader applications and is not specific to financial statements. As the name suggests, trend analysis involves identifying trends and predicting outcomes, which requires analyzing data from multiple consecutive periods. Horizontal analysis is an approach used to analyze financial statements by comparing specific financial information for a certain accounting period with information from other periods. Horizontal analysis looks at certain line items, ratios, or factors over several periods to determine the extent of changes and their trends.

Horizontal analysis definition

Consistency is important when performing horizontal analysis of financial statements. When the same accounting standards are used over the years, the financial statements of the company are easier to compare and trends are easily analyzed. Two popular methods that cover different needs are horizontal and vertical analysis. Vertical analysis, on the other hand, focuses on a specific period of time and studies the proportions of the total amount represented by the different variables for that period. Therefore, analysts and investors can identify factors that drive a company’s financial growth over a period of time. They are also in a position to determine growth patterns and trends, such as seasonality.

• The goal is to determine if the project’s estimated cash outflows will yield an adequate return on investment.
• A company’s financial statements – such as the balance sheet, cash flow statement, and income statement – can reveal operational results and give a clear picture of business performance.
• In this case, if management compares direct sales between 2007 and 2006 (the base year), it is clear that there is an increase of 3.2%.
• The identification of trends and patterns is driven by asking specific, guided questions.
• But, if you need more detailed analysis, you’ll want to view variances – either as percentages or dollar amounts.