Horizontal Analysis Financial Accounting

Integrating cash flow forecasts with real-time data and up-to-date budgets is a powerful tool that makes forecasting cash easier, more efficient, and shifts the focus to cash analytics. This would mean that the ratio of years 1, 2, and 3 to year one would be 100%, 97%, and 94%, respectively. In this example, the business’s variable expenses have trended downward over the three-year period. In this FAQ we will discuss what vertical analysis is, how it relates to horizontal analysis, and provide a simple example of how to apply it. Here’s an example of an income statement from a fictional company for the year that ended on September 28, 2019. These give the analyst insight into how much the line-item value has changed from the base period to the period being analyzed.

• For example, an Assets to Sales ratio is a measure of a firm’s productive use of Assets.
• The side-by-side display reveals changes in a company’s performance and highlights trends.
• It is also possible to perform this analysis with time series data to make direct comparisons with other companies.
• For example, if a company’s current year 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.

You can do horizontal analysis using only two periods for the comparison, but it’s highly recommended you use more to avoid drawing and acting on less accurate conclusions. Since we do not have any further information about the segments, we will project the future sales of Colgate based on this available data. We will use the sales growth approach across segments to derive the forecasts. Get instant access to video lessons taught by experienced investment bankers.

Horizontal analysis helps you spot trends

Likewise, the following is a horizontal analysis of a firm’s 2018 and 2019 balance sheets. Again, the amount and percentage differences for each line are listed in the final two columns and can be used to target areas of interest. For instance, the increase of $344,000 in total assets represents horizontal analysis of balance sheet a 9.5% change in the positive direction. There seems to be a relatively consistent overall increase throughout the key totals on the balance sheet. Even though the percentage increase in the equipment account was 107%, indicating the amount doubled, the nominal increase was just $43,000.

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. Once you have your company’s values for the variables of interest, you need to find those of similar companies in your industry for the selected time periods. Sometimes you may find horizontal analysis reports, saving you the calculations, but you can always calculate the percentage change yourself using publicly available financial data. Remember to choose companies with similar characteristics for useful comparisons.

Horizontal Analysis: Definition, Formula & Examples

In the same vein, a company’s emerging problems and strengths can be detected by looking at critical business performance, such as return on equity, inventory turnover, or profit margin. The comparative financial statements of Synotech, Inc., will serve as a basis for an example of horizontal analysis and vertical analysis of a balance sheet and a statement of income and retained earnings. Recall that horizontal analysis calculates changes in comparative statement items or totals, whereas vertical analysis consists of a comparison of items on a single financial statement. 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. It can also be used to compare growth rates and profitability over a period of time, across companies in the same industry.

Changes in accounting policies might mean that numbers in the same line item are not really comparable. It is important to look at the footnotes in the statement to determine if this is the case. Likewise, a large change in dollar amount might result in only a small percentage change which will not cause concern for the business owner. 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. If no problems exist industry-wide, one will observe a shortfall in Sales and rise in the dollar amount of Sales returns.

Why You Can Trust Finance Strategists

Thereby, achieving a goal of the budgeting process to determine the firm’s game plan. This ratio is a measure of the ability of a firm to turn Inventory into Sales. In this case, the higher the ratio, the better the business is using Inventory.

Horizontal analysis of income statements also produces worthwhile information. There were rises of more than 12% in all categories of property other than transport equipment. For example, an analyst may get excellent results when the current period’s income is compared with that of the previous quarter. However, the same results may be below par when the base year is changed to the same quarter for the previous year. Though there’s value in this approach, the current period may appear uncommonly good or bad, depending on the choice of the base year and the chosen accounting period the analysis begins with. 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.

Impact of Reporting Standards on Horizontal Analysis

For example, a low inventory turnover would imply that sales are low, the company is not selling its inventory, and there is a surplus. This could also be due to poor marketing or excess inventory due to seasonal demand. Ratios such as asset turnover, inventory turnover, and receivables turnover are also important because they help analysts to fully gauge the performance of a business. Fortunately, tools like Google Sheets or Excel allow you to set up templates, so you can forget about the calculations and focus on analysis.

It also compares a company’s performance from one period to another (current year vs. last year). Most importantly, Financial Analysis points to the financial destination of the business in both the near future and to its long-term trends. Financial statement analysis uses comparisons and relationships of data to enhance the utility or practical value of accounting information. This increase in capital expenditures is also reflected on the liability side of the balance sheet. Horizontal analysis is the comparison of historical financial information over various reporting periods.

Let us assume that variable expenses on year 1, 2, and 3 were $151, $147, and $142 respectively. Analysts are often concerned with a business’s performance over time and as a result, have a need to perform analysis over a period of time. You have acquired the 2010 Annual Report of the company and want to perform some horizontal and vertical analyses of the financial statements. As a working professional, business owner, entrepreneur, or investor, knowing how to read and analyze data from an income statement—one of the most important financial documents that companies produce—is a critical skill to have. There was a huge increase in cash-on-hand and a very meaningful increase in receivables, making total assets increase by nearly 50%.