Horizontal Analysis: How to Analyze Financial Statements

Horizontal analysis allows the assessment of relative changes in different items over time. It also indicates the behavior of revenues, expenses, and other line items of financial statements over the course of time. Trend analysis extends beyond simple period-to-period comparisons by examining data over a longer timeframe to identify consistent patterns or trends.

The Financial Model Best Practices I Teach All My Analysts

• Horizontal analysis is a financial analysis technique that compares financial information over multiple periods to identify trends and changes.
• Horizontal analysis can be conducted using various methods, each offering unique insights into a company’s financial performance over time.
• It is also possible to perform this analysis with time series data to make direct comparisons with other companies.
• Mike received his Bachelor of Science in Finance and a Master of International Business from the University of Florida, laying a solid foundation for his career in finance and accounting.
• For example, if your industry is seasonal, comparing consecutive quarters would provide misleading results.
• According to the variance, the financial impact was advantageous due to the rise in revenue.
• When Financial Statements are released, it is important to compare numbers from different periods in order to spot trends and changes over time.

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. Horizontal analysis is used to improve and enhance these constraints during financial reporting. A company’s financial performance over the years is assessed and changes in different line items and ratios are analyzed. Horizontal analysis can help you identify trends in your data using your financial statements. Using Excel or Google Sheets is a great way to carry out a horizontal analysis of financial statements, especially if you use a pre-made template. If you use Layer, you can even automate parts of this process, including the control of data flows, calculations, and sharing the results.

Horizontal Analysis using Balance Sheet

• Companies may choose to make a period of very poor financial performance the base period and compare all other financial periods with it.
• For example, earnings per share (EPS) may have been rising because the cost of goods sold (COGS) has been falling or because sales have been growing steadily.
• For example, an investor can use the horizontal analysis of the balance sheet to track the earnings per share ratio on a company he is thinking about investing in.
• Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping.
• These documents provide a comprehensive view of a company’s financial activities and position, making them ideal for horizontal analysis.
• Horizontal Analysis measures a company’s operating performance by comparing its reported financial statements, i.e. the income statement and balance sheet, to the financial results filed in a base period.

From 2023 to 2024, Reliance Industries’ revenue increased by Rs.1,00,000 crores, or 20%. The horizontal analysis formulas are employed to illustrate the revenue growth over time. We need to perform a horizontal analysis of the income statement of this company. 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 horizontal analysis accounting company’s net sales were $2 million, they will be presented as 100% ($2 million divided by $2 million).

Calculate Percentage Change

However, it is difficult to establish a definitive trend based on only two or three periods of data. For this reason, it is imperative to exercise caution when formulating conclusions in the absence of additional information. According to a study conducted by Green and Clark in 2019, the reliability of trend identification is enhanced by 30% when financial data is analysed over a decade.

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 this discussion and analysis of operations, Safeway’s management noted that the increase was due to a growing trend toward mortgage financing. In percentage comparison, the increase or decrease in amounts is expressed as a percentage of the amount in the base year. Insert a column to the right of ‘2022’ and click on the cell corresponding to the first revenue line item. Fortunately, tools like Google Sheets or Excel allow you to set up templates, so you can forget about the calculations and focus on analysis. Using Layer, you can also automate data flows and user management, so you can gather the data automatically, carry out the analysis, and automatically share results and reports with the right users. In conclusion, we’re able to compare the year-over-year (YoY) performance of our company from 2020 to 2021.

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You can also use horizontal analysis in conjunction with both the balance sheet and the income statement. For example, if the base year amount of cash is $100, a 10% increase would make the current accounting period’s amount $110, whereas a 10% decrease would be $90. Having identified a trend, the next step is to try and understand the reasons behind it by carrying out a more detailed investigation.

A horizontal analysis can be particularly illuminating when it includes calculations of key ratios or margins, such as the current ratio, interest coverage ratio, gross margin, and/or net profit margin. In particular, take note of any measurements included in a company’s loan covenants, since it makes sense to monitor trends in these measurements that could lead to a covenant breach. This type of presentation makes it easier to spot declining margins and/or liquidity problems early and make corrections before they can become serious concerns. This method of analysis makes it easy for the financial statement user to spot patterns and trends over the years.

Comparison Period to Base Period Percentage Change Example

Assume that ABC reported a net income of $15 million in the base year, and total earnings of $65 million were retained. The company reported a net income of $25 million and retained total earnings of $67 million in the current year. There were rises of more than 12% in all categories of property other than transport equipment. Although the variance analysis is useful, it is not always easy to spot trends in the financial information. This formula for evaluation is typically done by either investors and internal company management since both need to understand how well a company is doing in order to make decisions.