Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Still, horizontal and vertical analyses are meant to be complementary and used in conjunction with the other, so the user can obtain the most comprehensive understanding of a company’s historical performance and financial state as of the present date. By dividing the net difference by the base figure, the percentage change comes out to 25%. You can also choose to calculate income statement ratios such as gross margin and profit margin. We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
- You can choose to run a comparative balance sheet for the periods desired, or complete a side-by-side comparison of two years.
- If you purchased several fixed assets during 2018, the increase is easily explained, but if you didn’t, this would need to be researched.
- The example from Safeway Stores shows a comparative balance sheet for 2018 and 2019 following a similar format to the income statement above.
- Horizontal analysis is used to improve and enhance these constraints during financial reporting.
- To calculate the percentage change, first select the base year and comparison year.
It means that elements of financial statements, such as liabilities, assets, or expenses, may change between different accounting periods, leading to variation when account balances for each accounting period are sequentially compared. For instance, instead of creating a balance sheet or income statement for one specific period of time, you would also create a comparative income statement or balance sheet that covers quarterly or annual activity for your business. 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 method also enables the analysis of relative changes in different product lines and projections into the future. Looking at and comparing the financial performance of your business from period to period can help you spot positive trends, such as an increase in sales, as well as red flags that need to be addressed.
Step 1. Income Statement and Balance Sheet Assumptions
However, when using the analysis technique, the comparison (current) period can be made to appear uncommonly bad or good. It depends on the choice of the base year and the chosen accounting periods on which the analysis starts. Horizontal analysis looks at changes line by line between specific accounting periods, usually quarterly or yearly, whereas vertical analysis restates balance sheet or income statement amounts as a percentage of total assets (balance sheet) or net sales (income statement). Horizontal analysis, also known as trend analysis, is used to spot financial trends over a specific number of accounting periods.
For example, a company’s management may establish that the robust growth of revenues or the decline of the cost of goods sold as the cause for rising earnings per share. By exploring coverage ratios, interest coverage ratio, and cash flow-to-debt ratio, horizontal analysis can establish whether sufficient liquidity can service a company. Horizontal analysis can also be used to compare growth rates and profitability over a specific period across firms in the same industry. As outlined in the Generally Accepted Accounting Principles (GAAP), the rules for the preparation of financial statements require financial statements to be consistent and comparable to compare and evaluate companies and their financial performance properly. Consistency constraint here means that the same accounting methods and principles must be used each year since they remain constant over the years.
Horizontal analysis vs. vertical analysis: What’s the difference?
In the final section, we’ll perform horizontal analysis on our company’s historical balance sheet. We’ll start by inputting our historical income statement and balance sheet into an Excel spreadsheet. For example, if a company’s current year (2022) 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. While peer-to-peer comparisons are performed as part of the horizontal analysis process, it is important to consider the external variables that impact operating performance, especially any industry-specific considerations and market conditions.
- In conclusion, we’re able to compare the year-over-year (YoY) performance of our company from 2020 to 2021.
- Still, horizontal and vertical analyses are meant to be complementary and used in conjunction with the other, so the user can obtain the most comprehensive understanding of a company’s historical performance and financial state as of the present date.
- If you’re using an entry-level application, it’s likely you’ll need to use spreadsheets in order to complete the horizontal analysis.
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In fact, there must be a bare minimum of at least data from two accounting periods for horizontal analysis to even be plausible. In other words, vertical analysis can technically be completed with one column of data, but performing horizontal analysis is not practical unless there is enough historical data to have a useful point of reference. You can choose to run a comparative balance sheet for the periods desired, or complete a side-by-side comparison of two years. Using the comparative income statement above, you can see that your net income changed by $1,500 from 2017; a percentage increase of 5.3%, but what really stands out on the income statement is the 266% increase in depreciation expense. The comparative statement is then used to highlight any increases or decreases over that specific time frame. This enables you to easily spot growth trends as well as any red flags that may need to be addressed.
What is Horizontal Analysis?
The priority here should be to identify the company’s areas of strengths and weaknesses to create an actionable plan to drive value creation and implement operating improvements. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. If you purchased several fixed assets during 2018, the increase is easily explained, but if you didn’t, this would need to be researched. We’ll now move to a modeling exercise, which you can access by filling out the form below. In order to express the decimal amount in percentage form, the final step is to multiply the result by 100.
Subsequently, calculate the dollar change by subtracting the value in the base year from that in the comparison year and divide by the base year. If you’d rather see both variances and percentages, you can add columns in order to display changes in both. While this format takes the most time to create, it also makes it easier to spot trends and better analyze business performance. For example, if you run a comparative income statement for 2018 and 2019, horizontal analysis allows you to compare revenue totals for both years to see if it increased, decreased, or remained relatively stagnant. At least two accounting periods are required for a valid comparison, though in order to spot actual trends, it’s better to include three or more accounting periods when calculating horizontal analysis. Conceptually, the premise of horizontal analysis is that tracking a company’s financial performance in real time and comparing those figures to its past performance (and that of industry peers) can be very practical.
Step 3. Horizontal Analysis on Balance Sheet
Horizontal analysis, or “time series analysis”, is oriented around identifying trends and patterns in the revenue growth profile, profit margins, and/or cyclicality (or seasonality) over a predetermined period. In particular, the specific metrics and any notable patterns or trends that were identified can be compared across different companies — ideally to close competitors operating in the same industry — in order to evaluate each finding in more detail. Per usual, the importance of completing sufficient industry research cannot be overstated here.
Horizontal Analysis vs. Vertical Analysis
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. Vertical analysis expresses each line item on a company’s financial statements as a percentage of a base figure, whereas horizontal analysis is more about measuring the percentage change over a specified period. A notable problem with the horizontal analysis is that the compilation of financial information may vary over time.
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 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. 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. The value of horizontal analysis enables analysts to assess the company’s past performance and current financial position or growth and project the useful insights gained into the future.