For example, to find the growth rate of net sales for 2015, the formula is (Net Sales 2015 – Net Sales 2014) / Net Sales 2014. Likewise, we can do the same for all the other entries in the income statement. You do not need special financial skills to ascertain the difference between previous and last year’s data. However, it would be best if you had diligence, attention to detail, and a logical mind to decipher why the change happens. Whether you do a horizontal analysis quarterly or yearly, it’s worth the time and effort to perform this calculation regularly.

The company will need to further examine this difference before deciding on a course of action. Another method of analysis MT might consider before making a decision is vertical analysis.

Financial Accounting

The comparative statement is then used to highlight any increases or decreases over that specific time frame. This enables you to easily spot growth trends as well as any red flags that may need to be addressed. Though there’s value in this approach, the current period may appear uncommonly good or bad, depending on the choice of the base year and the chosen accounting period the analysis begins with. Given how 2020 was so widely different from years past, it’s hopefully an outlier for many industries as the global economy begins to recover from the pandemic. The comparability constraint dictates that your statements and documents need to be evaluated against companies similar to yours within the same industry. Horizontal analysis improves and enhances the constraints during financial reporting.

For example, an investor can use the horizontal analysis of the balance sheet to track the earnings per share ratio on a company he is thinking about investing in. If the ratio continues to grow year over year, the investor’s analysis would show a positive trend and he would probably choose to invest in the company granted other metrics are equally as positive. Horizontal analysis compares financial information over time, typically from past quarters or years.

Horizontal Analysis of Financial Statements

The dollar change is found by taking the dollar amount in the base year and subtracting that from the year of analysis. Ratios analysis is https://www.bookstime.com/ expressing relationships between two accounts where one number is divided into another to obtain a percentage, times, or a proportion.

• In this case, if management compares direct sales between 2007 and 2006 , it is clear that there is an increase of 3.2%.
• Two common activity ratios are accounts payable turnover and accounts receivable turnover.
• In the same vein, a company’s emerging problems and strengths can be detected by looking at critical business performance, such as return on equity, inventory turnover, or profit margin.
• Common-size balance sheets are useful for comparing a company to other companies or to industry averages.
• One reason is that analysts can choose a base year where the company’s performance was poor and base their analysis on it.
• You made $10 an hour and now your boss gives you a raise and pays you $12.

The method also enables the analysis of relative changes in different product lines and projections into the future. The overall growth has been relatively higher in the year 2018 compared to that of the year 2017. Nevertheless, it indicates that the company has witnessed continuous growth in the last two years. Step 2 – You can assume future growth rates based on the YoY or QoQ growth rates.

Horizontal or trend analysis of financial statements

Having completed the horizontal analysis and vertical analysis of Synotech’s balance sheet and statement of income and retained earnings, you are ready to study trend percentages and ratio analysis. The last section in this chapter discusses some final considerations in financial statement analysis. Professional financial statement analysts use several tools and techniques to determine the solvency and profitability of companies. Exhibit 134 provides the information needed to analyze Synotech’s comparative statements of income and retained earnings.

Horizontal analysis can also be used to benchmark a company with competitors in the same industry. 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. Horizontal analysis allows financial statement users to easily spot trends and growth patterns. Horizontal analysis is used to examine changes in different balance sheet items over a period of time. This formula for evaluation is typically done by either investors and internal company management since both need to understand how well a company is doing in order to make decisions. Investors have to make the decision whether or not they want to invest or sell their current investment; while management needs to know what moves to make in order to improve the future performance of the company.

Investors can use horizontal analysis to determine the trends in a company’s financial position and performance over time to determine whether they want to invest in that company. However, investors should combine horizontal analysis with vertical analysis and other techniques to get a true picture of a company’s financial health and trajectory.

For instance, a manager might compare cost of goods sold and profit margin over a two or three-year span to see how efficient the company is becoming. This comparison of income statements will give the manager not only a benchmark for future performance; it will also help horizontal analysis formula him understand what needs to be changed in the future. 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.

What is horizontal analysis?

However, the percentage increase in sales was greater than the percentage increase in the cost of sales. For example, in Safeway Stores’ balance sheets, both sales and the cost of sales increased from 2018 to 2019. Horizontal analysis of income statements also produces worthwhile information.

A horizontal analysis of the trends in liquidity ratios will reveal how well the company is able to meet its immediate obligations and serve as a tool for creditors to determine the viability and therefore creditworthiness of the company. Although a company wants to have a liquidity ratio that allows it to easily meet its current obligations, it does not want to have one that is so high that it reveals an inability to efficiently deploy cash into revenue-producing assets. The earliest period is usually used as the base period and the items on the statements for all later periods are compared with items on the statements of the base period.