Horizontal Analysis: What It Is vs Vertical Analysis

The business will need to determine which line item they are comparing all items to within that statement and then calculate the percentage makeup. These percentages are considered common-size because they make businesses within industry comparable by taking out fluctuations for size. It is typical for an income statement to use revenue (or sales) 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. The primary difference between vertical analysis and horizontal analysis is that vertical analysis is focused on the relationships between the numbers in a single reporting period, or one moment in time. Horizontal analysis looks at certain line items, ratios, or factors over several periods to determine the extent of changes and their trends.

Forecasting Future Performance

For example, suppose a business has conducted a horizontal analysis of its income statement over the last five years and found that its revenue grew at 10% yearly. In that case, it can use this information to set a revenue growth target for the future. For example, suppose a business conducts horizontal analysis on its income statement over two years and finds that its revenue has increased by 20%. By conducting horizontal analysis, businesses can evaluate their financial performance and identify areas where they are doing well and areas where they need to improve.

Methodology

By examining year-to-year horizontal analysis formula changes in key financial metrics, you can gain insights into a company’s growth, stability, and overall performance. Secondly, in the second type of horizontal analysis, we are interested in knowing about the underlying trends in the line items of the income statement. For this, we compare the absolute change ($) and percentage change (%) in all the line items from one period to the other. 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. 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.

Comparative Analysis Across Multiple Years

One reason is that analysts can choose a base year where the company’s performance was poor and base their analysis on it. In this way, the current accounting period (or any other accounting period) can be made to appear better. For example, in Safeway Stores’ balance sheets, both sales and the cost of sales increased from 2018 to 2019. Look for significant variations, both positive and negative, and identify any trends or patterns that emerge. Start by choosing the financial statements that are relevant to your analysis objectives. Consider which statements provide the most meaningful insights based on your analysis goals.

Data Analysis in Google Sheets (+ Tips and Examples)

The amount and percentage differences for each line are listed in the final two columns, respectively. In this GKSR example above, we can identify the YoY growth rate using a horizontal income statement analysis. Such analysis provides valuable insights into why any of these line items rose or fell sharply or markedly in year 2, compared to year 1.

Step 1: Gather Financial Information

The investor now needs to make a decision based on their analysis of the figures, as well as a comparison to other similar figures. Ratios such as asset turnover, inventory turnover, and receivables turnover are also important because they help analysts to fully gauge the performance of a business. Horizontal analysis can be performed annually or over any other relevant period, depending on the specific requirements and objectives of the analysis. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. From 2021 to 2020, we’ll take the comparison year (2021) and subtract the corresponding amount recorded in the base year (2020).

In this first example, I will be doing a horizontal analysis of Company A’s revenue https://www.bookstime.com/ based on its annual income statement. Now that you know how to calculate percentage change, you can read about all the steps involved in horizontal analysis in the next section. For instance, if a most recent year amount was three times as large as the base year, the most recent year will be presented as 300.

• Whether a company is expanding rapidly, maintaining stability, or facing decline, horizontal analysis offers an indispensable longitudinal perspective for making informed business decisions, budgeting, and strategic planning.
• In a horizontal analysis, comparisons can be done using either absolute comparisons or percentage comparisons.
• For example, companies may notice that their revenues have been growing over the course of a few years while their expenses have been relatively stable.
• After collecting the financial data for the selected financial statements, you analyze the changes in the financial data to identify trends and patterns.
• Determining the percentage change is important because it links the degree of change to the actual amounts involved.

Generally accepted accounting principles (GAAP) are based on the consistency and comparability of financial statements. Using consistent accounting principles like GAAP contra asset account ensures consistency and the ability to accurately review a company’s financial statements over time. Comparability is the ability to review two or more different companies’ financials as a benchmarking exercise. In summary, the purpose of horizontal analysis extends beyond simple calculation of growth rates. It serves as a multifaceted tool that enhances understanding of financial health, aids strategic planning, improves risk management, and ensures more effective communication with all stakeholders. This analysis is indispensable for maintaining a competitive edge and securing long-term sustainability in a fluctuating economic environment.