Horizontal analysis compares a company’s financial data over time, typically for two or more periods. By comparing data from different periods, statement of account a business can identify trends and patterns that may not be apparent when looking at data from a single period. Using both types together often gives the most comprehensive view of a company’s performance over time.

To further understand the application, let’s consider another example involving net income over three years. Insert a column to the right of ‘2022’ and click on the cell corresponding to the first line item. Google Sheets offers plenty of Data Analysis features that we can use to make sense of large data sets. You can change your settings at any time, including withdrawing your consent, by using the toggles on the Cookie Policy, or by clicking on the manage consent button at the bottom of the screen. From 2021 to 2020, we’ll take the comparison year (2021) and subtract the corresponding amount recorded in the base year (2020). In order to express the decimal amount in percentage form, the final step is to multiply the result by 100.

Comparing costs like COGS and operating expenses across periods and finding what could be more efficient is also a common use case for horizontal analysis. A manufacturer might notice that its expenses are rising faster than its sales, and closely look at cost control. A positive change in revenue might indicate business growth, while a decline in expenses could suggest improved cost management. However, it is also essential to evaluate external factors that might influence the results, such as economic trends or changes in market conditions. 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.

Step 3: Calculate Percentage Change

The concept emerged from the need to track financial metrics across reporting periods to spot variances and identify performance patterns. Some of the earliest documented uses of horizontal analysis date back to the 1920s and 1930s when accounting textbooks and publications began covering it as an important analytical approach. Its use expanded over the following decades as more companies adopted annual financial reporting and analysts needed tools to compare statements. The rise of spreadsheet software in the 1980s and 1990s made it much easier to apply horizontal analysis, further boosting its adoption. External factors such as economic conditions, industry trends, and competitive dynamics can significantly influence a company’s financial performance. For example, a rise in revenue might be attributed to favorable market conditions rather than internal improvements.

We’re diving into some real-life examples that’ll make horizontal analysis as easy as pie—or at least easier than understanding your phone bill. Vertical and horizontal analyses are both tools for financial statement analysis, but they differ in purpose. If the comparison year is year 3, then we will input the net income of year 3 and compute the percentage change between year 3 and year 1 (base year). 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.

Horizontal Analysis using Income Statements

Ensure that the financial statements are accurate, complete, and from a reliable source, as the quality of your analysis relies heavily on the integrity of the data. The balance sheet is a representation of a company’s financial status at a specific moment in time, including equity, liabilities, and assets. Horizontal analysis is a financial analysis technique that compares financial information over multiple periods to identify trends and changes. Horizontal analysis is used to assess a sequence of financial statement data over a specified time frame. By comparing financial results from prior periods with those from more recent periods, a company enhances its capacity to determine the direction and magnitude of account balance movements. These examples demonstrate how horizontal analysis enables us to identify trends and patterns in various financial metrics.

Marketplace Financial Model Template

The horizontal analysis relies heavily on historical data, which may not accurately reflect future performance. It doesn’t account for external factors or industry changes that may impact financial results. Also, horizontal analysis alone may not provide a comprehensive understanding of a company’s financial health and requires additional analysis and context.

  • Liquidity is a critical aspect of a company’s financial health, as it determines its ability to meet short-term obligations and seize opportunities.
  • Horizontal analysis helps businesses identify trends, evaluate, forecast future performance, and benchmark themselves against their peers.
  • With real-time dashboards, they could track costs instantly and make better decisions.
  • Per usual, the importance of completing sufficient industry research cannot be overstated here.

Imagine you’re analyzing Company DEF’s financial data for 2022 and 2023, and you want to use rolling averages, regression analysis, and industry benchmarking to gain deeper insights. In today’s digital age, financial software has become a valuable asset for automating many aspects of horizontal analysis. Software tools can streamline data collection, calculation, and visualization, saving time and reducing the risk of errors. For instance, a common-size income statement would show what percentage of revenue is allocated to various expenses, providing insights into cost structures.

Identifying Trends

As you can see, horizontal analysis is a versatile tool with diverse applications across finance, working capital formula investment, risk assessment, internal performance evaluation, and regulatory compliance. Understanding how to use horizontal analysis effectively can provide valuable insights and drive informed decision-making in various professional roles and contexts. Regulatory authorities often require companies to perform horizontal analysis as part of their financial reporting obligations. This analysis ensures transparency and compliance with accounting standards, allowing stakeholders to make informed decisions. Vertical analysis, ratio analysis, and cash flow analysis are commonly used alongside horizontal analysis to gain a comprehensive understanding of a company’s financial position. In this second example, I will do a horizontal analysis of Company B’s current assets based on the annual balance sheets.

To illustrate, consider an investor who wishes to determine Company ABC’s performance over the past year before investing. 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. For example, a company might use horizontal analysis to compare its revenue from one year to the next to see if it is growing or declining.

  • When used together, both methods provide a more detailed view of a company’s financial health.
  • Analyzing operating cash flow trends over time can reveal how effectively the company manages its day-to-day cash flow and whether it is self-sustaining.
  • This information helps in making informed investment and lending decisions, assessing the company’s ability to generate profits, and understanding its operational efficiency.

The method is also called trend analysis because it shows a business’s performance trajectory. Companies can use horizontal analysis to track any financial data consistently over time. For example, companies may track annual sales revenue or quarterly operating expenses to determine growth patterns.

Dollar change horizontal analysis calculates the pnl explained faq absolute difference between the values in two periods. It shows the exact monetary change, helping businesses and analysts see how much a financial figure has increased or decreased. This method is useful when you want to understand the real numerical change in line items like revenue, expenses, or net income.

Regression analysis is a powerful statistical technique used in horizontal analysis to predict future values based on historical data. By fitting a regression model to financial data, you can make informed forecasts and projections. Operating cash flow is a key indicator of a company’s ability to generate cash from its core business operations. Analyzing operating cash flow trends over time can reveal how effectively the company manages its day-to-day cash flow and whether it is self-sustaining. The final step in horizontal analysis is interpreting the results of your analysis. This involves drawing meaningful conclusions from the trends, patterns, and changes you’ve identified.

For example, in the income statement, we can, based on historical data and trends, make assumptions about sales growth and then forecast the sales growth rates through the forecast periods. Suppose you are the financial analyst of a company that operates in the retail industry. You have been tasked with conducting a horizontal analysis of the company’s income statement for the past two years to identify trends and patterns in its financial performance.