For example, a company’s management may establish that the robust growth of revenues or the decline of the cost of goods sold as the cause for rising earnings per share. By exploring coverage ratios, interest coverage ratio, and cash flow-to-debt ratio, horizontal analysis can establish whether sufficient liquidity can service a company. Horizontal analysis can also be used to compare growth rates and profitability over a specific period across firms in the same industry. Collect financial statements (income statements, balance sheets, and cash flow statements) for at least two consecutive years. Horizontal analysis is a vital tool in the arsenal of financial analysts, offering a dynamic view of a company’s financial health over time.
It’s a Revenue and Expense Trend Detector
For example, if revenue is growing but net income is declining, this could indicate rising costs or inefficiencies that are eroding profitability. Conversely, if both revenue and net income are increasing, it suggests that the company is not only growing but also managing its costs effectively. This holistic view helps stakeholders understand the underlying drivers of financial performance and make more informed decisions.
It helps you understand how efficiently a company is managing its costs and whether there are any notable changes in expense categories over time. Once you have financial data from different periods, the tricky part is organizing and comparing it. They also help you see trends in real-time, and make it faster to spot changes and make crucial decisions. Given below is a horizontal analysis in excel of a comparative income statement (i.e. year 1 – base, year 2, and year 3). These formulas are used to evaluate trends which can either be quarter-on-quarter or year-on-year depending on the accounting period from which the data is sourced.
The process of comparing performance over time reveals whether the business is growing, managing expenses, or reinvesting its earnings in research and development. For example, if a company’s current year (2022) revenue is $50 million in 2022 and its revenue in the base period, 2021, was $40 million, the net difference between the two periods is $10 million. If certain historical eras of underperformance are chosen as a comparison, horizontal analysis can be used to make the current period appear better. Below is the calculation for revenue that increased from Rs. 100,000 in 2017 to Rs. 150,000 in 2018. CAGR measures the average annual growth rate of a financial metric over a specific period.
It’s an Early Warning System for Cash Flow Issues
- These ratios provide a snapshot of various aspects of a company’s performance, liquidity, solvency, and profitability.
- Then, we would find the difference between the second quarter’s gross sales and the first.
- A less-used format is to include a vertical analysis of each year in the report, so that each year shows each line item as a percentage of the total assets in that year.
- The concept emerged from the need to track financial metrics across reporting periods to spot variances and identify performance patterns.
- This helps in understanding how efficiently a company is managing its costs relative to its revenue.
By analyzing historical trends, we’re more capable of projecting future performance. Next, select a “base period” and a “current period.” The base period is typically the earliest period in your comparison, serving as the reference point against which all subsequent periods will be measured. For example, if comparing 2023 what is horizontal analysis and 2024 data, 2023 would commonly be chosen as the base year.
The three key components of financial statements used in horizontal analysis are the balance sheet, income statement, and cash flow statement. Each of these provides important metrics that allow analysts to assess a company’s performance over time. 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. 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. Performing horizontal analysis involves a series of structured steps that allow you to assess a company’s financial performance over multiple periods effectively.
Horizontal Analysis: Metrics, Methods, and Applications
Welcome to the power of horizontal analysis, where time becomes your most valuable analytical tool. While a single financial statement is like a photograph, horizontal analysis is the full motion picture—revealing the story and trends behind the numbers and exposing trends that can make or break strategic decisions. Preparation involves aligning corresponding line items from each financial statement across the selected periods. This means ensuring that “Revenue” from the base period is directly compared to “Revenue” from the current period, and similarly for “Cost of Goods Sold,” “Accounts Receivable,” or any other item.
- An expense category that commences at Rs. 1,000 and increases to Rs. 2,000 represents a 100% increase, but only a Rs. 1,000 variance in actual rupees.
- This percentage allows for easier comparison of growth or decline across different accounts, regardless of their absolute values.
- Look for consistent positive or negative changes in financial metrics to assess the overall direction and performance of the company.
- By assessing the changes in revenues, expenses, profits, assets, and liabilities, you can gauge the overall financial well-being of the organization.
- Inflation, like from recent tariffs, can distort horizontal analysis by making moderate growth appear more robust than reality.
Horizontal analysis is one of the most fundamental analyses of historical financial information that you can perform. Expense trend analysis reveals management discipline and operational efficiency. The best companies show expense growth rates that lag revenue growth rates, creating positive operating leverage and margin expansion. Tracking current assets over time reveals liquidity trends and operational efficiency.
Vertical analysis focuses on a single period and expresses each line item as a percentage of a base figure, such as total revenue or assets. It’s great for assessing cost structures or understanding how individual components contribute to overall performance within one period. It can be revenue, COGS, expenses or any other financial ratio you want to track. This way, you’ll get a snapshot of the company’s performance over time, and will be able to compare them. Finally, because horizontal analysis relies on the financial statements it is subject to the nuances of accounting policies that might not paint an accurate picture of the business’s actual performance over time. The most obvious benefit of horizontal analysis is that helps paint a picture of how a business has performed over time.
First, we noted that Colgate had not provided segmental information in the income statement. However, as additional information, Colgate has provided some details of segments on page 87. The investor may desire to understand how the firm has altered over time to decide. For example, if that Company XYZ’s net income was $10 million and retained earnings were $50 million at the start of its existence, as depicted by example. For companies that can’t yet justify the cost of a full-time CFO, it’s best to consider getting fractional support so that you get strategic insights without the executive-level salary burden. A 20% expense increase might look alarming until you discover it resulted from strategic investments in market expansion or technology upgrades that will drive future growth.
If inflation has influenced the financial data, it is essential to adjust the figures to account for its impact. One common method is using an inflation index or Consumer Price Index (CPI) to calculate the inflation-adjusted values. Drag down the cell with the formula to copy it to the other current assets line items.
However, it would be best if you had diligence, attention to detail, and a logical mind to decipher why the change happens. Below is a break down of subject weightings in the FMVA® financial analyst program. As you can see there is a heavy focus on financial modeling, finance, Excel, business valuation, budgeting/forecasting, PowerPoint presentations, accounting and business strategy.