Financial Analysis and Interpretation: Horizontal Analysis HKT Consultant

By converting raw financial data into percentages, it becomes easier to identify trends and anomalies that might be obscured in absolute numbers. For example, if a company’s cost of goods sold (COGS) as a percentage of sales has been steadily increasing, it could indicate rising production costs or inefficiencies that need to be addressed. This level of insight is invaluable for management when making strategic decisions. Horizontal analysis (also known as trend analysis) looks at trends over time on various financial statement line items. A business will look at one period (usually a year) and compare it to another period.

Selecting the Base Year: Establishing a Reference Point

Both can provide useful insights, but they serve different purposes and may be more effective when used in combination. Those who wish to invest can use horizontal analysis to determine the performance status of a company. The technique shows whether or not the company is expanding and appreciating in terms of value.

• 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.
• Let’s say you’re an FP&A analyst in ACME Inc., and you know that its revenue in Q1 was $8 million, and it increased to $9.2 million in Q2.
• The Direct Comparison Method entails the direct comparison of numbers from one accounting period to those from another.
• When it comes to analyzing financial statements, businesses have various tools at their disposal.
• Horizontal analysis serves as a powerful tool in financial decision-making, providing valuable insights that can guide strategic planning, investment decisions, and operational improvements.
• Examining the income statement through horizontal analysis can highlight trends in revenue growth, cost management, and overall profitability.

Collect Data

By combining horizontal analysis with tools like FP&A software and scenario planning, companies can make decisions that are not just reactive but also forward-thinking. Let’s say you’re an FP&A analyst in ACME Inc., and you know that its revenue in Q1 was $8 million, and it increased to $9.2 million in Q2. Ideally, the base year should be a period characterized by relative stability and normalcy. Avoid selecting years that were significantly impacted by unusual events such as economic recessions, major acquisitions, or significant regulatory changes. Although this type of analysis is not a comprehensive approach, it can help as a starting point to evaluate a potential investment opportunity.

Reporting Standards and Horizontal Analysis

For balance sheet analysis, total assets, or total liabilities and equity, are used as the base amounts. When financial statements are converted to percentages, they are called common-size financial statements. The following two examples of vertical analysis use information from an abbreviated income statement and balance sheet.

The base year serves as the cornerstone for comparative analysis, providing a benchmark against which subsequent periods are evaluated. For comparative analysis to be meaningful, it is imperative that consistent accounting methods are applied across all periods under review. For instance, comparing revenue figures from the past three years can immediately reveal whether the company is experiencing consistent growth, stagnation, or decline.

Horizontal Analysis Vs. Vertical Analysis

Analyzing balance sheets is a crucial aspect of financial analysis, allowing businesses and individuals to assess their financial health and make informed decisions. It involves examining the assets, liabilities, and equity of a company to gain insights into its financial position. Vertical analysis which of these are the same as horizontal analysis? offers a snapshot of a company’s financial structure at a specific point in time. It expresses each line item as a percentage of a base figure, typically total assets for the balance sheet or total revenue for the income statement.

• Tracking these metrics over time provides insights into a company’s financial stability and growth trajectory.
• It typically compares financial data for varied periods (months, quarters, two years, and so on).
• This guide is designed to give first-time sellers everything they need to know about how to choose the best advisor for their unique situation.
• According to a study conducted by Green and Clark in 2019, the reliability of trend identification is enhanced by 30% when financial data is analysed over a decade.
• Another method of analysis MT might consider before making a decision is vertical analysis.
• By identifying patterns and trends in financial data using horizontal analysis, businesses can make informed decisions about their operations and investments.

In the same way, the absolute change is as described below if the cost of products sold was Rs. 60,000 in 2019 and Rs. 90,000 in 2020. For example, let’s say Reliance Industries had revenue of Rs.5,00,000 crores in 2023 (base year) and revenue of Oil And Gas Accounting Rs.6,00,000 crores in 2024 (current year). Despite its usefulness, horizontal analysis has certain limitations that must be considered. Notice that the same information was used for both the horizontal and vertical analyses examples but that the results are different because of how the dollar amounts are being compared.

Remember, financial statements are not just numbers—they tell a story of your organization’s journey. Retail businesses might use horizontal analysis to track seasonal sales fixed assets patterns, while vertical analysis helps optimize inventory levels. Manufacturing companies can use horizontal analysis to monitor production efficiency over time, and vertical analysis to assess the impact of raw material costs on overall expenses. Using horizontal analysis in monthly or quarterly reviews helps businesses track performance trends and spot potential issues.

Horizontal Analysis using Balance Sheet

By comparing their financial data to industry averages or competitors’ financial data, businesses can gain insights into how they perform relative to their peers. Horizontal analysis, which is also known as trend analysis, is a method used to compare financial data over a series of periods. One of the major criticisms of horizontal analysis is that it can at times produce biased results. This is because the beginning period will determine how the growth and trajectory appear.