Horizontal Analysis vs Vertical Analysis What’s the Difference?

The most obvious benefit of horizontal analysis is that helps paint a picture of how a business has performed over time. Trends are used when projecting future performance and analysts use them to identify where they believe the business is within the business cycle. As a result, utility costs for the company are expressed as 1% of the base amount. The remaining items on the income statement, such as rent payments, sales, and other expenses, can all be calculated using the same method. Take into account that a company’s net income from the base year, which was $400,000, increased to $500,000 this year.

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• As the name suggests, trend analysis involves identifying trends and predicting outcomes, which requires analyzing data from multiple consecutive periods.
• This can be useful because it allows you to make comparisons across different sets of numbers.
• Consistency is also crucial for comparability between different companies within the same industry.
• For example, if you are comparing quarterly data, ensure that each quarter’s financial statement represents a three-month period ending on the same month.
• While horizontal analysis focuses on changes over time, vertical analysis emphasizes the relative importance of different line items within a single period.
• Given below is a horizontal analysis in excel of a comparative income statement (i.e. year 1 – base, year 2, and year 3).

To ensure cash flow consistency and comparability, make sure that you have annual or quarterly financial statements with equal intervals between each statement. For example, if you are comparing quarterly data, ensure that each quarter’s financial statement represents a three-month period ending on the same month. On the other hand, vertical analysis is focused on examining relationships between individual accounts or line items within a single financial statement.

Company Valuation: How to Value Your Business?

The findings of common size analysis as compiled in the preliminary stages of due diligence are critical. For example, to find the growth rate of net sales for 2015, the formula is (Net Sales 2015 – Net Sales 2014) / Net Sales 2014. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. For example, a low inventory turnover would imply that sales are low, the company is not selling its inventory, and there is a surplus.

Understanding Horizontal Analysis

One crucial aspect to consider when performing horizontal analysis is the need for consistency. Consistency ensures that financial statements remain comparable and Retail Accounting reliable over time. This applies to both the financial reporting standards used, as well as the calculation methods employed during the analysis process. Let us dive deeper into the importance of consistency in horizontal analysis and how it impacts financial statement analysis. Moreover, horizontal analysis helps investors assess a target company’s financial position relative to competitors in terms of financial leverage (i.e., debt-to-equity ratio) and liquidity ratios.

One of the overall goals of horizontal analysis is to help users gauge what stage the business is in. When performing financial statement analysis, it is important to compare performance over time. First, decide which periods you will be comparing, carefully choosing comparable periods. For example, if your industry is seasonal, comparing consecutive quarters would provide misleading results.

• The investor now needs to make a decision based on their analysis of the figures, as well as a comparison to other similar figures.
• By performing a horizontal analysis on the financial statements of a company over multiple years, investors and analysts can easily identify trends, growth patterns, and changes in key performance indicators (KPIs).
• Financial analysis allows investors to make sense of a company’s financial data and compare one company to another.
• This could also be due to poor marketing or excess inventory due to seasonal demand.
• 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.

Horizontal Analysis in Different Financial Statements

It is also possible to perform this analysis with time series data to make direct comparisons with other companies. For example, in Safeway Stores' balance sheets, both sales and the cost of sales increased from 2018 to 2019. This method of analysis makes it easy for the financial statement user to spot patterns and trends over the years. Now that you know how to calculate percentage change, you can read about all the steps involved in horizontal analysis in the next section. Example of Horizontal Analysis In a horizontal analysis, changes from the baseline are typically displayed in dollars and percentages.

Finance Strategists has an advertising relationship with some of the companies included on this website. We may earn a commission when you click on a link or make a purchase through the links on our site. All of our content is based on objective analysis, and the opinions are our own. The investor now needs to make a decision based on their analysis of the figures, as well as a comparison to other similar figures.

Also, when an analysis is presented on a repetitive basis over many reporting periods, any changes in the comparison periods should be disclosed, to make readers aware of the difference. Here, for the sake of illustration, we have shown the absolute change (in US$) and percentage change (%) of all line items in the income statement between year 1 and year 2 only. We can now see how much any item, such as net income, increased or decreased from year 1 (base year) to year 3 in absolute and percentage terms. In other words, we can calculate how much net income increased or decreased from year 1 to year 3 (or for that matter any year). Here net income has decreased by $2,750 or 12% in year 3 when compared to year 1.