Horizontal Analysis: What It Is vs Vertical Analysis

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. How detailed your initial financial statements are depends largely on the accounting software application you’re using. If you’re using an entry-level application, it’s likely you’ll need to use spreadsheets in order to complete the horizontal analysis. https://www.bookstime.com/ 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. These changes express how much a specific financial item has increased or decreased over time in terms of a percentage. Analyzing percentage changes helps you determine not only the magnitude of the change but also its direction, whether it’s positive or negative.

Step 3: Identify Trends and Patterns

• Finance Strategists has an advertising relationship with some of the companies included on this website.
• Horizontal analysis is used in financial statement analysis to compare historical data, such as ratios, or line items, over a number of accounting periods.
• A company’s financial performance over the years is assessed and changes in different line items and ratios are analyzed.
• Horizontal analysis also makes it easier to detect when a business is underperforming.
• Horizontal analysis is only one technique which can be used to analyze financial information.
• Carrying out horizontal analysis of the income statement and balance sheet helps investors and creditors to determine the current financial position of a company.

For example, MT saw a 50% accounts receivable increase from the prior year to the current year. If they were only expecting a 20% increase, they may need to explore this line item further to determine what caused this difference and how to correct it going forward. It could possibly be that they are extending credit to customers more readily than anticipated or not collecting as rapidly on outstanding accounts receivable. The company will need to further examine this difference before deciding on a course of action. Another method of analysis MT might consider before making a decision is vertical analysis.

Key Learning Points

In horizontal analysis, understanding the concept of base year and current year is crucial. The base year serves as the reference point for comparisons, while the current year represents the year under scrutiny. By comparing the current year’s financial data to that of the base year, you gain insights into changes and trends. The major distinction between horizontal and vertical analysis is that horizontal analysis compares numbers from multiple reporting periods, whereas vertical analysis compares figures from a single reporting period.

Gather Financial Statements

In the above example, some of the expenses were increasing at a much faster rate than the revenue resulting in a reduction in net income. Either way it is important to identify the reason and correct the problem as necessary. In this report, 2019 is identified as the base year, and each line item for the other two years 2020, and 2021 is calculated as a percentage of the same line item for the base year. The horizontal analysis formula used to calculate the % base column is shown in the example below for the revenue line item.

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. Horizontal analysis isn’t limited to external stakeholders; it is also a valuable tool for companies to evaluate their own financial performance. By comparing financial data over time, organizations can make informed decisions and strategic adjustments. Whether you’re an individual investor, a portfolio manager, or part of an investment team, horizontal analysis provides valuable insights into a company’s financial health and growth prospects.

• Changes between the income from operations and net income lines can be reviewed to identify the reasons for the relatively lower increase in net income.
• Per usual, the importance of completing sufficient industry research cannot be overstated here.
• Most horizontal analysis entail pulling quarterly or annual financial statements, though specific account balances can be pulled if you’re looking for a specific type of analysis.
• Several interesting balance sheet changes are apparent in the tables below.
• You can choose whatever interval (month-over-month, year-over-year, etc.), but each iterative financial statement should be equal distance away regarding when it was issued compared to other bits of financial information.
• Horizontal analysis is most useful when an entity has been established, has strong record-keeping capabilities, and has traceable bits of historical information that can be dug into for more information as needed.

Percentage Changes and Trends

Let’s cut through the noise and get straight to the nitty-gritty of horizontal analysis. You’ve got your numbers, you’ve done the math, but there are still some landmines that can blow up your carefully crafted analysis. To standardize the output for the sake of comparability, the next step is to divide by the base period.

What Is the Difference Between Horizontal Analysis and Vertical Analysis?

• For example, an analyst may get excellent results when the current period’s income is compared with that of the previous quarter.
• Dollar amount changes provide a clear picture of the absolute differences in financial figures over time.
• This can be useful if you’re comparing the numbers with industry averages or rules of thumb, but horizontal analysis is a far better way to gauge the success (or lack) of the strategic decisions being made in the company.
• If you make any alterations to the way your figures are calculated, make sure you take a note of that in your horizontal analysis.
• If you purchased several fixed assets during 2018, the increase is easily explained, but if you didn’t, this would need to be researched.
• It’s one of the most significant skills that employers look for in potential employees.
• Depending on their expectations, Mistborn Trading could make decisions to alter operations to produce expected outcomes.

Step 2: Determine Comparison Methods