Horizontal or Trend Analysis of Financial Statements Explanation and Example

In this case, if management compares direct sales between 2007 and 2006 , it is clear that there is an increase of 3.2%. For example, in Safeway Stores’ balance sheets, both sales and the cost of sales increased from 2018 to 2019. You can also use horizontal analysis in conjunction with both the balance sheet and the income statement.

If you are an investor considering investing in a company, only a year-end balance sheet or income statement would not be enough to judge how a company is doing. Better yet, you can see many years of balance sheets and income statements and compare them. With horizontal analysis, you look at changes horizontal and vertical analysis line-by-line, between specific accounting periods – whether it be monthly, quarterly, or annually. Horizontal analysis is a process used in financial statements such as comparing line items across several years for the purpose of tracking the firms progress and historical performance.

Horizontal Analysis of Financial Statements

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. You use horizontal analysis to find and monitor trends over a period of time. Instead of creating an income statement or balance sheet for one period, you would also create a comparative balance sheet or income statement to cover quarterly or annual business activities. Horizontal analysis sometimes referred to as trend analysis, is used to identify trends over a particular number of accounting periods.

Further, operating income and net income have also witnessed higher growth due to a lower increase in SG&A expense and income tax respectively. The dollar change is found by taking the dollar amount in the base year and subtracting that from the year of analysis. Drag down the cell with the formula to copy it to the other current assets line items.

What Are the Benefits of Horizontal Analysis?

From the balance sheet’s horizontal analysis you may see that inventory and accounts payable have been growing as a percentage of total assets. For instance, if management establishes the revenue increase or decrease in the cost of goods sold is the reason for rising earnings per share, the horizontal analysis can confirm. With metrics like the cash flow to debt ratio, coverage ratios, interest coverage ratio, and other financial ratios, the horizontal analysis can determine whether sufficient liquidity can service the company. It can also be https://www.bookstime.com/ used to compare growth rates and profitability over a period of time, across companies in the same industry. 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. Accurate analysis can be affected by one-off events and accounting charges. A company’s financial statements – such as the balance sheet, cash flow statement, and income statement – can reveal operational results and give a clear picture of business performance.

Vertical analysis shows a comparison of a line item within a statement to another line item within that same statement. For example, a business may compare cash to total assets in the current year. This allows a business to see what percentage of cash makes up total assets during the period.

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This type of question guides itself to selecting certain horizontal analysis methods and specific trends or patterns to seek out. 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. Also known as profit and loss (P&L) statements, income statements summarize all income and expenses over a given period, including the cumulative impact of revenue, gain, expense, and loss transactions. Income statements are often shared as quarterly and annual reports, showing financial trends and comparisons over time. 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.

Since horizontal analysis is expressed in percentage change over time, it is often confused with vertical analysis. The two are entirely different with the primary difference between them being that horizontal examines the relationship between numbers across various periods and vertical analysis is only concerned with a single period. Vertical analysis, horizontal analysis and financial ratios are part of financial statement analysis.

What is the difference between vertical analysis and horizontal analysis?

Within an income statement, you’ll find all revenue and expense accounts for a set period. Accountants create income statements using trial balances from any two points in time. The purpose of an income statement is to show a company’s financial performance over a period. Ratios such as earnings per share, return on assets, and return on equity are similarly invaluable. These ratios make problems related to the growth and profitability of a company evident and clear. An absolute comparison involves comparing the amount of the same line of the item to its amounts in the other accounting periods.

• Here’s an example of an income statement from a fictional company for the year that ended on September 28, 2019.
• Accurate analysis can be affected by one-off events and accounting charges.
• These documents can also show a company’s emerging successes and potential weaknesses, based on metrics such as inventory turnover, profit margin, and return on equity.
• If you happen to choose a particularly bad time period for your base values, the values for your comparison period may look much better than they are.
• A manager, on the other hand, is concerned with the day-to-day operations of the company, so he uses this evaluation technique to pinpoint areas for improvement.
• A fundamental part of financial statement analysis is comparing a company’s results to its performance in the past and to the average industry benchmark set by comparable peers in the same industry.

This income statement shows that the company brought in a total of $4.358 billion through sales, and it cost approximately $2.738 billion to achieve those sales, for a gross profit of $1.619 billion. Let’s take a look at this simple example before we discuss any further.Each item in a financial statement is compared to the base year.

Colgate Horizontal Analysis

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• What this means is that things like assets, revenues, expenses, or liabilities may have also shifted between various accounts.
• If the previous year’s amount was twice the amount of the base year, it will be presented as 200.
• Better yet, you can see many years of balance sheets and income statements and compare them.
• They can then use this information to make business decisions such as preparing the budget, cutting costs, increasing revenues, or investments in property plant or equipment.
• To perform a horizontal analysis, you must first gather financial information of a single entity across periods of time.
• The level of detail in your financial statements depends heavily on the accounting software you use.