12 7: Horizontal and Vertical Trend Analysis Business LibreTexts

horizontal analysis formula

Horizontal analysis is a powerful tool for understanding and evaluating a company’s financial performance over time. By examining year-to-year changes in key financial metrics, you can identify trends, assess stability, and make informed business decisions. Remember to consider industry benchmarks, peer analysis, and best practices to ensure accurate and meaningful results. By incorporating horizontal analysis into your financial analysis toolkit, you can gain valuable insights into your company’s performance and drive strategic growth. Horizontal analysis allows investors and analysts to see what has been driving a company’s financial performance over several years and to spot trends and growth patterns. This type of analysis enables analysts to assess relative changes in different line items over time and project them into the future.

Cash Flow Statement

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 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). To illustrate, consider an investor who wishes to determine Company ABC’s performance over the past year before investing.

Example: Horizontal Analysis of a Balance Sheet

At least two of these statements are compared, but having and comparing three or more statements makes horizontal analysis easier, more accurate, and reliable. These changes are either in the form of dollar amount (variance) and percentage. You can calculate these changes by comparing items in the base accounting period with other items in subsequent periods and financial statements. Horizontal Navigating Financial Growth: Leveraging Bookkeeping and Accounting Services for Startups analysis typically shows the changes from the base period in dollar and percentage. For example, a statement that says revenues have increased by 10% this past quarter is based on horizontal analysis. The percentage change is calculated by first dividing the dollar change between the comparison year and the base year by the line item value in the base year, then multiplying the quotient by 100.

horizontal analysis formula

Account for external factors influencing financial trends

Being aware of these pitfalls and challenges in horizontal analysis will help you navigate them effectively, ensuring that your analysis provides accurate and actionable insights into financial performance and trends. Mastering these advanced techniques and tools can significantly enhance your ability to extract meaningful insights from financial data and make informed decisions based on your horizontal analysis findings. Liquidity is a critical aspect of a company’s financial health, as it determines its ability to meet short-term obligations and seize opportunities. Analyzing liquidity changes over time helps you gauge the company’s ability to cover its immediate cash needs. Equity represents the owners’ stake in the company and is a key indicator of the company’s net worth. Analyzing equity changes over time can provide insights into how the company has financed its operations and whether it has generated profits or incurred losses.

horizontal analysis formula

Key benefits of horizontal analysis

To conclude, it is always worth performing horizontal analysis, but it should never be relied upon too heavily. Other factors should also be considered, and only then should a decision be made. For example, a low inventory turnover would imply that sales are low, the company is not selling its inventory, and there is a surplus.

Above, you are presented a comparative retained earning statement for the years 2020 and 2021. You can see every important item from the retained earnings from the previous year to the net income, dividends, and the retained earnings by the end of the year. Both years are compared with each other and it can be seen generally that there has been a significant increase in earning from all sources.

  • These methods go beyond basic percentage changes and provide deeper insights into a company’s financial performance and trends.
  • Last, a horizontal analysis can encompass calculating percentage changes from one period to the next.
  • Horizontal analysis is a financial analysis method that compares historical financial data over a series of periods to identify trends, patterns, and fluctuations in a company’s performance.
  • Generally accepted accounting principles (GAAP) are based on the consistency and comparability of financial statements.
  • Likewise, the following is a horizontal analysis of a firm’s 2018 and 2019 balance sheets.

A horizontal analysis of Jonick’s 2018 and 2019 income statements appears above. The amount and percentage differences for each line are listed in the final two columns, respectively. Benchmark the company’s financial performance against industry averages or key competitors.

horizontal analysis formula