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. The key advantage of using horizontal analysis is that it allows for the visual identification of anomalies from long-running trends. By presenting data on a comparative basis, changes in the data are more readily apparent. In addition, the use of horizontal analysis makes it easier to project trends into the future. Yet another advantage of this form of data presentation is when trends can be compared to those of competitors or industry averages, to see how well an organization’s performance compares with that of other entities. Every single item is compared with its counterpart in the alternative income statement.

• Linking the 3 statements together in Excel is the building block of financial modeling.
• This way, companies willfully maneuver and change their growth and profitability trends to their advantage.
• Developing your interpersonal skills and improving in Ways of Knowing you can better understand financial statement analysis.
• 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.
• All of the amounts on the balance sheets and the income statements for analysis will be expressed as a percentage of the base year amounts.

Utilize financial ratios, such as profitability ratios, liquidity ratios, and solvency ratios, to compare the company’s financial performance with industry benchmarks and competitors. This provides a comprehensive view of the company’s relative strengths and weaknesses. As it is majorly carried out on a single time period, Vertical analysis is also known as static analysis. Results from vertical analysis over multiple financial periods can be particularly useful while conducting regression analysis. Accountants see relative changes in company accounts over a given period of time and determine the best strategy to improve the relationship between financial items and variables.

Horizontal analysis definition

Frequently,
these percentage increases are more informative than absolute amounts, as
illustrated by the current asset and current liability changes. Although the absolute
amount of current liabilities has increased tremendously over the amount of
current assets, the percentages reveal that current assets increased .5 per
cent, while current liabilities increased 8.6 per cent. This fact indicates that the company will be
able to pay its debts as they come due.

If anything, they only let you stay in compliance with regulatory standards such as GAAP. You also need to reliably understand how your business is fairing and this is where financial statement analysis comes in. Through horizontal analysis, the different items can be seen to have different increases and decreases, with each item only compared with its corresponding counterpart in the alternate balance sheet. Positive or negative trends are spotted and this method serves as more reliable when presenting external stakeholders like investors and creditors with your company’s financial health.

By analyzing changes in revenue, expenses, and assets over time, companies can make informed decisions and better understand their financial performance. Analysis tools can help you compare companies of different sizes, companies in different industries, and the same company over time. You can calculate these changes by comparing items in the base accounting period with other items in subsequent periods and financial statements. Horizontal Analysis, also known as Trend Analysis, is an analysis technique in accounting used over financial statements such as balance sheets, statements of retained earnings, and income statements, among others. Likewise, the following is a horizontal analysis of a firm’s 2018 and 2019 balance sheets.

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. Adding a third year to the analysis will be even more helpful, as you’ll be able to see if there is a definite trend. Insert a column to the right of ‘2022’ and click on the cell corresponding to the first revenue line item. From 2021 to 2020, we’ll take the comparison year (2021) and subtract the corresponding amount recorded in the base year (2020). Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs.

Analysis of Financial Statements

For example, if a company starts generating low profits in a particular year, expenses can be analyzed for that year. This makes it easier to spot inefficiencies and specific areas of underperformance. For example, in Safeway Stores’ balance sheets, both sales and the cost of sales increased from 2018 to 2019. Determining the percentage change is important because it links the degree of change to the actual amounts involved.

Again, the amount and percentage differences for each line are listed in the final two columns and can be used to target areas of interest. For instance, the increase of $344,000 in total assets represents a 9.5% change in the positive direction. There seems billing and payment terms sample clauses to be a relatively consistent overall increase throughout the key totals on the balance sheet. Even though the percentage increase in the equipment account was 107%, indicating the amount doubled, the nominal (just the number) increase was just $43,000.

What is financial statement analysis?

Using Layer, you can also automate data flows and user management, so you can gather the data automatically, carry out the analysis, and automatically share results and reports with the right users. 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. The findings of common size analysis as compiled in the preliminary stages of due diligence are critical. Today, investors quickly flip to this section to see if the company is actually making money or not and what its funding requirements are.

Drawbacks of Horizontal Analysis

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. To perform a horizontal analysis, you must first gather financial information of a single entity across periods of time. 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.

By leveraging the insights gained from horizontal analysis, businesses can make informed decisions, mitigate risks, and drive sustainable growth. Now look at Columns (11) and (12) to see the vertical analysis that would be performed. Columns (11) and (12) express the dollar amount of each item in Columns (7) and (8) as a percentage of net sales. Even though cost of goods sold increased in 2010, it remained a fairly constant percentage of net sales. The percentage of expenses to net sales decreased somewhat, thus yielding an increase in income before income taxes as a percentage of net sales. Next, study Column (4),
which expresses as a percentage the dollar change in Column (3).

Here, for the sake of illustration, we have shown the absolute change (in US$) and percentage change (%) of all line items in the income statement between year 1 and year 2 only. 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. In this second example, I will do a horizontal analysis of Company B’s current assets based on the annual balance sheets. In fact, there must be a bare minimum of at least data from two accounting periods for horizontal analysis to even be plausible.

A business will look at one period (usually a year) and compare it to another period. For example, a business may compare sales from their current year to sales from the prior year. 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.