Horizontal analysis is used to improve and enhance these constraints during financial reporting. Consistency constraint here means that the same accounting methods and principles must be used each year since they remain constant over the years. This can happen when the analyst modifies the number of comparison periods used to make the results appear unusually good or bad. For example, the current period’s profits may appear excellent when only compared with those of the previous month, but are actually quite poor when compared to the results for the same month in the preceding year.

• An alternative format is to 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.
• Second, a variance analysis determines not only the dollar amount but the direction of change for a given general ledger account.
• Horizontal analysis can also be used to compare growth rates and profitability over a specific period across firms in the same industry.
• The value of horizontal analysis enables analysts to assess the company’s past performance and current financial position or growth and project the useful insights gained into the future.

Creditors and investors use vertical analysis to compare a company’s financial performance to that of others in the same industry. Horizontal income statement analysis is typically done in a two-year manner, as shown below, with a variance that shows the difference between the two years for each line item. Begin by accumulating financial statements from different quarters or years, as horizontal analysis is performed on financial statements throughout time. These formulas are used to compare trends across time, which might be quarter-to-quarter or year-to-year, depending on the accounting period from which the data is derived.

Horizontal Analysis on Income Statement Example

For example, a statement that says revenues have increased by 10% this past quarter is based on horizontal analysis. The percentage change is calculated by first dividing the dollar change between the comparison year and the base year by the line item value in the base year, then multiplying the quotient by 100. Last, a horizontal analysis can encompass calculating percentage changes from one period to the next. As a company grows, it often becomes more difficult to https://accounting-services.net/difference-between-horizontal-analysis-and/ sustain the same rate of growth, even if the company grows in pure dollar size. This percentage method is most useful when identifying changes over a longer period of time where there may be significant deviations from the base period to the current period. 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.

As in the prior step, we must calculate the dollar value of the year-over-year (YoY) variance and then divide the difference by the base year metric. The latter two tend to go hand-in-hand because the most useful benchmark against which to compare recent performance is most often the preceding period. By dividing the net difference by the base figure, the percentage change comes out to 25%. To standardize the output for the sake of comparability, the next step is to divide by the base period. Another option is to add as many years as would fit on the page without providing a variance, allowing you to view overall changes by account over time.

Problems with Horizontal Analysis

These and similar questions call attention to areas that require further study. One item of note becomes more apparent as a result of the trend analysis above. Initially, it was stated that operating expenses were increasing between 2019 and 2021. Based on trend analysis, however, these expenses are actually declining as a percentage of sales.

Everything You Need To Master Financial Statement Modeling

Later, this data could be used to conduct a more in-depth examination of financial performance. 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. Be mindful that the gaps between each financial statement are consistent. You can choose whatever interval (month-over-month, year-over-year, etc.), but each iterative financial statement should be equal distance away regarding when it was issued compared to other bits of financial information. Per usual, the importance of completing sufficient industry research cannot be overstated here. In each industry, market participants attempt to solve different problems and encounter various obstacles, resulting in financial performance that reflects a given industry’s state.

How to Perform a Horizontal Analysis

It depends on the choice of the base year and the chosen accounting periods on which the analysis starts. The primary difference between vertical analysis and horizontal analysis is that vertical analysis is focused on the relationships between the numbers in a single reporting period, or one moment in time. Vertical analysis is also known as common size financial statement analysis. Horizontal analysis is used in financial statement analysis to compare historical data, such as ratios, or line items, over a number of accounting periods. Horizontal analysis can either use absolute comparisons or percentage comparisons, where the numbers in each succeeding period are expressed as a percentage of the amount in the baseline year, with the baseline amount being listed as 100%.

By Industry

To illustrate, consider an investor who wishes to determine Company ABC’s performance over the past year before investing. Assume that ABC reported a net income of $15 million in the base year, and total earnings of $65 million were retained. The company reported a net income of $25 million and retained total earnings of $67 million in the current year.

This type of analysis reveals trends in line items such as cost of goods sold. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.