Horizontal Analysis Financial Accounting

The beginning inventory balance in the current year is taken from the ending inventory balance in the prior year. Average total assets are found by dividing the sum of beginning and ending total assets balances found on the balance sheet. The beginning total assets balance in the current year is taken from the ending total assets balance in the prior year. Solvency implies that a company can meet its long-term obligations and will likely stay in business in the future.

Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. Adding a third year to the analysis will be even more helpful, as you’ll be able to see if there is a definite trend. Today, investors quickly flip to this section to see if the company is actually making money or not and what its funding requirements are. In our course on Analysis of Financial Statements, we explore all the above metrics and ratios in great detail. For the below example, revenue in Year 3 was $55,749, and in Year 2, it was $53,494. The YoY change in revenue is equal to $55,749 / $53,494 minus one, which equals 4.2%.

Learning Outcomes

Horizontal analysis of the income statement is usually in a two-year format, such as the one shown below, with a variance also shown that states the difference between the two years for each line item. An alternative format is to simply add as many years as will fit on the page, without showing a variance, so that you can see general changes by account over multiple years. A third format is to include a vertical analysis of each year in the report, so that each year shows expenses as a percentage of the total revenue in that year. Horizontal analysis is a process used to analyzed financial statements by comparing the specific financial information for a particular accounting period with information from another period. If we take historical data of the financial statements of a company for year 1 and year 2, then one can compare each item and how it has changed year-over-year. With horizontal analysis, you easily compare the financial position and performance of your company from one period to the next.

• Select the base and comparison periods and the values for your chosen variable, then calculate the percentage change between them.
• The higher the figure, the better the company is using its investments to create a profit.
• To get a more valid analysis, however, at least three financial statements are used.
• In this case, current assets were $200,000, and current liabilities were $100,000.
• This analysis gives the company a heads up if cost of goods sold or any other expense appears to be too high when compared to sales.

Converting information to percentages or ratios eliminates some of the disparity between competitor sizes and operating abilities, making it easier for stakeholders to make informed decisions. It can assist with understanding the makeup of current operations within the business, and which shifts need to occur internally to increase productivity. Horizontal analysis trend percentage can be found by finding the balance sheet, income statement and cash flow statement by the scheduling of current and fixed assets and statement of retained earnings.

Vertical Analysis

The following figure is an example of how to prepare a vertical analysis for two years. As with the horizontal analysis, you need to use more years for any meaningful trend analysis. This figure compares the difference in accounts from 2014 to 2015, showing each account as a percentage of sales for each year listed. Vertical analysis restates each amount in the income statement as a percentage of sales.

Horizontal analysis is often referred to as trend analysis, but the latter term has broader applications and is not specific to financial statements. As the name suggests, trend analysis involves identifying trends and predicting outcomes, which requires analyzing data from multiple consecutive periods. 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. In this part of our analysis of financial statements, we unlock the drivers of financial performance.

Implementing vertical analysis

Companies may choose to make a period of very poor financial performance the base period and compare all other financial periods with it. This way, companies willfully maneuver and change their growth and https://turbo-tax.org/tax-dates-and-deadlines-in-2021/ profitability trends to their advantage. For more detailed representations of how horizontal analysis really works, here are a few examples with balance sheets, income statements, and retained earnings.

You also need to reliably understand how your business is fairing and this is where financial statement analysis comes in. For this technique to be used, at least two financial statements (of the same type) need to be in existence. To get a more valid analysis, however, at least three financial statements are used. The more statements available and used for analysis, the greater the results obtained. Now that you know how to calculate percentage change, you can read about all the steps involved in horizontal analysis in the next section.

Common Size Analysis of Financial Statements

An income statement tallies income and expenses; a balance sheet, on the other hand, records assets, liabilities, and equity. If you’d rather see both variances and percentages, you can add columns in order to display changes in both. While this format takes the most time to create, it also makes it easier to spot trends and better analyze business performance. On the other hand, horizontal analysis looks at amounts from the financial statements over a horizon of many years. The analysis of critical measures of business performance, such as profit margins, inventory turnover, and return on equity, can detect emerging problems and strengths.

• Horizontal Analysis, like every other accounting process, is only accurate or possible when certain defined steps are followed.
• In order to answer these questions, and much more, we will dive into the income statement to get started.
• The information obtained from this analysis can benefit decision-making for internal and external stakeholders and can give a company valuable information on overall performance and specific areas for improvement.

We will also apply this formula to each line item to calculate its percentage change. 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. For example, if a company starts generating low profits in a particular year, expenses can be analyzed for that year. This makes it easier to spot inefficiencies and specific areas of underperformance.