Above, you are presented a comparative retained earning statement for the years 2020 and 2021. You can see every important item from the retained earnings from the previous year to the net income, dividends, and the retained earnings by the end of the year. Both years are compared with each other and it can be seen generally that there has been a significant increase in earning from all sources.

However, an extra vertical analysis approach is required for management and innovators to make better-informed judgments. Later, this data could be used to conduct a more in-depth examination of financial performance. Another way to see this is where the base period was unusually poor, taking the year 2020 which was greatly affected by the COVID pandemic for example.

Formulas for horizontal analysis

Financial analysis helps you examine relationships between different financial items and determine efficient operations to manage them. From the above examples, the horizontal analysis only pushes to present the changes in these different periods and offer companies or businesses easy pointers to the health of their financial growth and situations. However, more than two financial statements need to be compared to obtain more reliable results for proper financial analysis. To make horizontal analysis even more helpful, you can project future performance.

However, the same results may be below par when the base year is changed to the same quarter for the previous year. The significance of the various increases and decreases in the revenue and ex­pense items should be investigated to see if operations could be further improved. For example, the increase in utilities expense of 38.9% was the result of renting additional office space for use by a part-time law student in performing paralegal services. This explains the increase in rent expense of 25.0% and the increase in wages expense of 33.3%. The increase in revenues of 25.0% reflects the fees gener­ated by the new paralegal.

In this free guide, we will break down the most important types and techniques of financial statement analysis. The horizontal method of analysis is used to identify changes in financial statements over time and assess those changes. Also like horizontal analysis, vertical analysis can be useful in external as well as internal analysis. Two companies with vastly different financial profiles (e.g., a $10 million company and a $10 billion dollar international corporation) can still be meaningfully compared by reducing their financials to percentages.

  • 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.
  • One should ideally take three or more accounting periods/years to identify trends and how a company is performing from one year/accounting period to the next year/accounting period.
  • This percentage method is most useful when identifying changes over a longer period of time where there may be significant deviations from the base period to the current period.
  • It is also useful for inter-firm or inter-departmental performance comparisons as one can see relative proportions of account balances, regardless of the size of the business or department.
  • This can be done by extrapolating data from the past and applying it to future periods.

To calculate the percentage change, first select the base year and comparison year. 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. The preceding example illustrates how horizontal analysis can be useful in inter­preting and analyzing the income statement. Horizontal analyses can also be performed for the balance sheet, the retained earnings statement, and the statement of cash flows. A single item in a financial statement, such as net income, is often useful in interpreting the financial performance of a company.

Free Financial Modeling Lessons

Horizontal analysis allows financial statements used to easily spot trends and growth patterns. Another method of horizontal analysis is calculating the variance between multiple financial items in multiple financial statements and free accounting software for small business spanning multiple accounting periods. Trend Analysis is a technique used to identify trends spanning different accounting periods by highlighting the changes in different financial statements when comparing items to each other.

This might aid the company in generating effective projects and planning for the future. This type of analysis has the advantage of allowing for the visual identification of anomalies from long-term trends. It incorporates computations of key ratios or margins, such as the current ratio, interest coverage ratio, gross margin, and/or net profit margin, which can be highly insightful.

Developing your interpersonal skills and improving in Ways of Knowing you can better understand financial statement analysis. Horizontal analysis is a process used to analyzed financial statements by comparing the specific financial information for a particular accounting period with information from another period. 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. Using this formula, the analyst can determine the percentage change between two years for any given financial statement line item.

With horizontal analysis, you easily compare the financial position and performance of your company from one period to the next. With your findings, you understand how much change you have in your revenue (increase or decrease) between the two periods in consideration and also spot changes in your COGS and net income. This makes it easy to see how your company performs over time and identify trends or patterns. For example, you might compare a company’s revenue from last year to its revenue from this year or its net income from last year to its net income from this year. For example, you can compare your company’s revenue from last year to this year or your company’s net income from last year to this year.

An absolute comparison involves comparing the amount of the same line of the item to its amounts in the other accounting periods. For example, comparing the accounts receivables of one year to those of the previous year. Today’s economy is undergoing constant and significant change thanks to digital disruption, complex globe-spanning phenomena like climate change and the COVID-19 pandemic, and the ever-expanding impact (and importance) of Big Data. To compete effectively and strategically, it’s important for businesses of all sizes to make use of the tools at their disposal. Both horizontal and vertical analysis each have a role to play in a company’s financial management, business process management, and overall strategic and competitive planning.

E-Commerce Profit and Loss Statement

There’s a wealth of data lurking inside your company’s financial statements—and if you know how to analyze it effectively, you can transform financial information into actionable insights. Two of the most common, and effective, ways to do so are horizontal analysis and vertical analysis. Common-size financial statements express each line item as a percentage of a base amount, typically total revenue or total assets. This allows for easy comparison and identification of trends across different periods. Comparative income statements with vertical analysis can be compared to give a company an idea of its financial health spanning years.

Horizontal Analysis of Financial Statements

This could prove to be the main factor enabling the company to attain a consistent increase in net income and, therefore, the main point of focus in maintaining it. Additionally, the financial statements to be provided need to be respective statements for the accounting periods to be compared. At least two of these statements are compared, but having and comparing three or more statements makes horizontal analysis easier, more accurate, and reliable. These formulas are used to evaluate trends which can either be quarter-on-quarter or year-on-year depending on the accounting period from which the data is sourced. For horizontal analysis, it’s best to take several years of historical data to gain useful insights into how a company is performing.

The first step to performing horizontal analysis is to calculate the net difference — in dollar terms ($) — between the comparable periods. 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. Horizontal analysis is considered the most important financial statement analysis and for the annual reports. ASD Inc. manufactures precision components for Tier-I OEMs (Original equipment manufacturers). Percentage changes show the year-to-year variations in financial metrics and help determine the growth or decline rate of the company’s performance.

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. Horizontal analysis compares amount balances and ratios over a different time period. The analysis computes the percentage changes in each income statement amount at the far right.

While this format takes the most time to create, it also makes it easier to spot trends and better analyze business performance. Depending on which accounting period an analyst starts from and how many accounting periods are chosen, the current period can be made to appear unusually good or bad. For example, the current period’s profits may appear excellent when only compared with those of the previous quarter but are actually quite poor if compared to the results for the same quarter in the preceding year.

If you’re looking for a comprehensive guide to horizontal analysis, you’ve come to the right place. This blog post will discuss what horizontal analysis is, why it’s important, and how to perform it correctly. For this example, the analysis will be carried out on the data reported for 2021 and 2022.