Horizontal analysis can be performed by comparing a recent year against the base year while identifying the growth trends between the time periods. The analysis can be performed in any four types of financial statement i.e. income statement, balance sheet, statement of cash flow, and statement of changes in equity. However, income statement and balance sheet are mostly used financial statement to do horizontal analysis . Vertical analysis is the financial statement in which all items of a financial statement are presented in percentages. In vertical analysis, balance sheet items and income statement items are expressed in percentage. All balance sheet accounts are presented as a percentage of the total assets and all income statement items are presented as a percentage of sales (Ott, Riddiough, & Yi, 2009).
For example, earnings per share may have been rising because the cost of goods sold has been falling or because sales have been growing steadily. Coverage ratios, like the cash flow-to-debt ratio and the interest coverage ratio, can reveal how well a company can service its debt through sufficient liquidity and whether that ability is increasing or decreasing. Horizontal analysis also makes it easier to compare growth rates and profitability among multiple companies in the same industry. This means Mistborn Trading saw an increase of $20,000 in revenue in the current year as compared to the prior year, which was a 20% increase. The same dollar change and percentage change calculations would be used for the income statement line items as well as the balance sheet line items.
How Is Horizontal Analysis Performed?
First, we noted that Colgate had not provided segmental information in the income statement. However, as additional information, Colgate https://www.bookstime.com/ has provided some details of segments on page 87. Step 2 – You can assume future growth rates based on the YoY or QoQ growth rates.
For example, using financial ratios can be helpful in determining costs or identifying changes in processes to increase savings. 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. Because they are turning over their Inventory without the cost of it becoming obsolete. As business owners, we are so busy with the day-to-day operations of running a business that we may forget to take a look at our business as a whole and ignore any company financial statement analysis. Consider enrolling in Financial Accounting or our other online finance and accounting courses, which can teach you the key financial topics you need to understand business performance and potential.
The Income Statement vs. the Balance Sheet
When performing financial statement analysis, it is important to compare performance over time. A horizontal analysis can be particularly illuminating when it includes calculations of key ratios or margins, such as the current ratio, interest coverage ratio, gross margin, and/or net profit margin. In particular, take note of any measurements included in a company’s loan covenants, since it makes sense to monitor trends in these measurements that could lead to a covenant breach. This type of presentation makes it easier to spot declining margins and/or liquidity problems early and make corrections before they can become serious concerns.
- Growth Profile → Finding profitable growth opportunities in a market is a challenging task in itself, but capitalizing on the opportunity once identified can be even more difficult.
- This can be used to compare different aspects of a company, such as sales, profits, and expenses.
- The investor may desire to understand how the firm has altered over time to decide.
- Regardless of how useful trend analysis may be, it is regularly criticized.
- The purpose of an income statement is to show a company’s financial performance over a period.
- It helps investors analyze and ascertain whether the company has had consistent growth over the years and if they are utilizing fund available in a balanced way.
For example, if Mistborn Trading set total assets as the base amount and wanted to see what percentage of total assets were made up of cash in the current year, the following calculation would occur. At the bottom of the analysis, note that net income, as a percentage of sales, declined by 2.62 percentage points (6.67 percent to 4.05 percent). Management should consider both the percentage change and the dollar amount change. Horizontal analysis is important because it allows you to compare data between different periods and makes it easier to identify changes in trends. This can be helpful in making decisions about whether to invest in a company or not.
Example of Horizontal Analysis Formula (With Excel Template)
Horizontal analysis can be manipulated to make the current period look better if specific historical periods of poor performance are chosen as a comparison. In this GKSR example above, we can identify the YoY growth rate using a horizontal income statement analysis. In horizontal analysis addition, it helps us identify potential areas of growth and concerns. You can also choose to calculate income statement ratios such as gross margin and profit margin. Horizontal, or trend, analysis is used to spot and evaluate trends over a specific period of time.
This figure compares the difference in accounts from 2014 to 2015, showing each account as a percentage of sales for each year listed. To prepare a vertical analysis, you select an account of interest and express other balance sheet accounts as a percentage. For example, you may show merchandise inventory or accounts receivable as a percentage of total assets. A good way to do some ratio and trend analysis work is to prepare both horizontal and vertical analyses of the income statement. Both analyses involve comparing income statement accounts to each other in dollars and in percentages. Horizontal analysis of the income statement is usually in a two-year format, such as the one shown below, with a variance also shown that states the difference between the two years for each line item.
create an account
Then, we calculate the growth rate of each of the line items concerning the previous year. Calculating the horizontal analysis of a balance sheet is a similar process. 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’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. Horizontal analysis is a common technique used to examine the changes in the line items of the income statement and the balance sheet from year to year.
With a Horizontal Analysis, also, known as a “trend analysis,” you can spot trends in your financial data over time. While the definition of an income statement may remind you of a balance sheet, the two documents are designed for different uses. An income statement tallies income and expenses; a balance sheet, on the other hand, records assets, liabilities, and equity.
It is typical for an income statement to use revenue as the comparison line item. This means revenue will be set at 100% and all other line items within the income statement will represent a percentage of revenue. Finally, because horizontal analysis relies on the financial statements it is subject to the nuances of accounting policies that might not paint an accurate picture of the business’s actual performance over time.
Horizontal 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. Vertical analysis refers to the method of financial analysis where each line item is listed as a percentage of a base figure within the statement. This means line items on income statements are stated in percentages of gross sales, instead of in exact amounts of money, such as dollars. Since, any line item in a financial statement or financial ratio can be compared across a period of time, it makes the horizontal analysis extremely useful for anyone trying to track a company’s performance over time.
The trending of items on these financial statements can give a business valuable information on overall performance and specific areas for improvement. It is most valuable to do horizontal analysis for information over multiple periods to see how change is occurring for each line item. If multiple periods are not used, it can be difficult to identify a trend. The year of comparison for horizontal analysis is analysed for dollar and percent changes against the base year. On the other hand, total current liabilities, common stock, total current assets and cash has increased value. This indicates the company is performing well but it should use the cash in settling the current liabilities or invest it to maximize the return. Indeed, sometimes companies change the way they break down their business segments to make the horizontal analysis of growth and profitability trends more difficult to detect.
- They can use them internally to examine issues such as employee performance, the efficiency of operations and credit policies.
- Horizontal analysis also makes it easier to detect when a business is underperforming.
- In fact, there must be a bare minimum of at least data from two accounting periods for horizontal analysis to even be plausible.
- There was a huge increase in cash-on-hand and a very meaningful increase in receivables, making total assets increase by nearly 50%.
- This data can be pulled from your company’s financial statements, such as the balance sheet, income statement, and cash flow statement.