Horizontal Analysis: Analyzing Financial Trends for Future Ready Businesses

Percentage changes show the year-to-year variations in financial metrics and help determine the growth or decline rate of the company’s performance. Start by choosing the financial statements that are relevant to your analysis objectives. Consider which statements provide the most meaningful insights based on your analysis goals.

Through horizontal analysis of financial statements, you would be able to see two actual data for consecutive years and would be able to compare every item. 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. On the other hand, comparability constraint dictates that a company’s financial statements and other documentation be such that they can be evaluated against other similar companies within the same industry.

Industry Benchmarking and Peer Analysis

The two examples below show how to do horizontal analysis using Google Sheets, but you can easily do the same in Excel. The first example is based on a balance sheet, stale dated checks and the second is on an income statement. The Direct Comparison Method entails the direct comparison of numbers from one accounting period to those from another.

Income Statement and Balance Sheet Assumptions

Vertical analysis is a financial analysis technique that compares financial data to a base period or benchmark to determine the relative proportions of each data component. For example, it shows the percentage of each item in relation to a base item in the same period. Utilize financial ratios, such as profitability ratios, liquidity ratios, and solvency ratios, to compare the company’s financial performance with industry benchmarks and competitors. This provides a comprehensive view of the company’s relative strengths and weaknesses.

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. The first step in horizontal analysis is grabbing the company’s financial statements. We’re talking about the Income Statement and Balance Sheet—the bread and butter of financial reporting. 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.

B. Choose Comparison Periods

Use month-over-month or year-over-year, but do not combine quarterly or annual statements in the same analysis. Horizontal analysis offers several benefits that enhance financial decision-making and performance evaluation. Let’s illustrate these formulas with a practical example using revenue data for two consecutive years. Fortunately, tools like Google Sheets or Excel allow you to set up templates, so you can forget about the calculations and focus on analysis. Using Layer, you can also automate data flows and user management, so you can gather the data automatically, carry out the analysis, and automatically share results and reports with the right users.

Calculate Dollar Amount Changes

This is because vertical analysis expresses each line in the financial statements as a percentage of a base value, like sales. Horizontal analysis is a method of financial statement analysis used to compare statement items (or financial ratios) across multiple periods. It’s called “horizontal” because the data in financial statements is laid out, and compared side by side, or horizontally.

The process of comparing performance over time reveals whether the business is growing, managing expenses, or reinvesting its earnings in research and development. Although the company’s net income has increased, it has not kept pace with the increase in revenues, which could be a cause for concern. You notice that the company’s revenues have increased by 15% from the previous year, while its cost of goods sold has increased by only 10%. This indicates that the company has is debit positive or negative expanded its profit margin, as it has been able to sell its products at a higher price or reduce costs. This involves looking for areas where there have been significant increases or decreases and considering the reasons behind these changes.

Ensure the accuracy and completeness of the data, as any inaccuracies can affect the analysis results.
To illustrate the application of horizontal analysis on balance sheets, let’s examine a hypothetical example of Company ABC’s balance sheets for 2022 and 2023.
Changes in equity also reveal whether the company’s net worth is increasing or whether it needs to raise capital.
These typically include income statements, balance sheets, and cash flow statements for the years you wish to analyze.

Horizontal analysis of Wipro’s financial statements over two years provides insights into the company’s changing financial performance. While revenues declined slightly, Wipro improved gross profit margins and operational cash flows, indicating effective financial management despite a marginal drop in overall profitability. The cash flow statement is also beneficial for horizontal analysis, in addition to the income statement and balance sheet.

Strong cash flow from operations enables a company to reduce its dependence on external financing. 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).

Horizontal Analysis using Balance Sheet

Although it is beneficial for monitoring historical trends, it does not offer any predictions regarding future outcomes. Horizontal analysis does not include forward-looking data, such as budgets, forecasts, and leading indicators, which would offer a predictive perspective. For example, we perform a horizontal analysis of the income statement for the years ended March 31, 2023, and March 31, 2024, for Wipro Limited. The cash flow statement highlights the inflows and outflows of cash from operations, investments, and financing. Horizontal analysis examines trends in accounts such as cash from operations, capital expenditures, and cash from loans or equity financing.

It helps determine the consistent growth rate, smoothing out fluctuations in year-to-year changes. Carefully examine the percentage changes to understand the magnitude and significance of variations. Look for major fluctuations that may indicate critical events or shifts in the company’s operations. For example, if net sales increase from $58,081 to $65,455, the dollar amount of the change is $7,374. Dividing this by the old amount ($58,081) gives a percentage change of approximately how revenue affects the balance sheet 12.7%. For liabilities, if accounts payable decreased by $4,197, the percentage change would be approximately -30.5%.

For this reason, it is imperative to exercise caution when formulating conclusions in the absence of additional information.
Remember to choose companies with similar characteristics for useful comparisons.
Horizontal analysis focuses on changes between consecutive periods, whereas trend analysis often spans a more extended period to show patterns.
Variance analysis compares actual financial performance with the expected or budgeted performance.

To conduct horizontal analysis, collect financial statements prepared according to GAAP, determine comparison methods, calculate absolute and percentage changes between periods, and analyse trends. As explained in Jones’ 2022 research published in the Journal of Financial Analysis, over 80% of companies rely on these methods to gain insights into trends and growth from period to period. Horizontal analysis focuses on comparing absolute amounts and percentages across different time periods, typically over the course of years. When conducting horizontal analysis, several metrics stand out as particularly informative. Revenue growth is often the first metric examined, as it provides a clear picture of how a company’s sales are evolving over time. By comparing revenue figures from different periods, analysts can gauge whether the company is expanding its market presence or facing challenges in maintaining its sales levels.

Common-Size Statements

This will allow you to interpret these results within as comprehensive a context as possible. 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. It would make more sense to compare the values for a specific quarter to the same quarter from past years. If you happen to choose a particularly bad time period for your base values, the values for your comparison period may look much better than they are. Select the base and comparison periods and the values for your chosen variable, then calculate the percentage change between them.