Horizontal Financial Statement Analysis


Definition of Horizontal Analysis

Horizontal analysis examines financial statements.

It analyzes ratios and line items over accounting periods. Accounting periods might be months, quarters, or years.

This analysis is called trend analysis.

Horizontal analysis is used to track and evaluate financial statement changes.

Base year is chosen as a baseline. Data from other years is either compared as a percentage of the base year or absolute. Comparison of base years is base year analysis.

Financial statement users can easily discover patterns and trends over time with this analytical method.

Absolute comparisons compare the same item line’s amount to other accounting periods. Example: comparing accounts receivable from one year to the previous. Then, modifications are assessed.

Percentage comparisons show changes as a percentage of the base year.

If the base year cash is $100, a 10% rise would make the current accounting period $110, whereas a 10% decrease would be $90.

EPS and current ratios are also compared across accounting periods.

Horizontal Analysis: Explanation

Horizontal analysis examines year-to-year dollar and percentage changes in specific accounts.

The percentage change is crucial because it ties the degree of change to the amounts involved. Thus, percentage changes are better for business comparisons than dollar changes.

A $1 million rise in General Motors’ cash balance is likely to be a far smaller percentage gain than American Motors’.

To calculate percentage changes, use this formula:

Percentage change = dollar change / base year amount × 100

Comparisons always start with the base year.

Say Safeway’s current assets were $1,729,146,000 in 2018 and $1,861,389,000 in 2019. A $132,243,000 money gain and 7.65% percentage increase are calculated as follows:

Change percentage = ($1,861,389,000 – $1,729,146,000 / 100) x 100

= 7.65%

Horizontal analysis can be used with the balance sheet and income statement.

Safeway Stores’ comparative balance sheets and income statements are below. The tables show dollar and percentage changes.

The tables below show several intriguing balance sheet adjustments. Safeway Stores expanded fixed asset operations in 2019. All property categories except transport equipment rose more than 12%.

Capital expenditures have increased liabilities on the balance sheet. Above 53%, notes and debentures rose.

Safeway’s management explained the increase as a mortgage finance trend in its operations review.

Compare Balance Sheets Horizontally

Compare Income Statements Horizontally

Horizontal income statement analysis is also useful.

In Safeway Stores’ balance sheets from 2018 to 2019, sales and cost of sales grew.

The sales percentage rise exceeded the cost percentage increase. This increased gross profit from 2018 to 2019.

Operating and administrative expenses rose modestly, and interest expense rose over 12%. This only slightly increased net income for 2019 over 2018.

The Value of Horizontal Analysis

In GAAP, consistency and comparability are expected.

Horizontal financial statement analysis requires consistency. Using the same accounting standards over time makes corporate financial statements easier to compare and analyze trends.

Comparability is comparing a company’s financial statements to another in its industry.

Horizontal analysis shows investors, analysts, and other stakeholders the company’s financial performance.

The financial performance of a company over time is evaluated and line item and ratio changes are examined. Examine negative patterns and changes.

Horizontal analysis also helps identify underperforming businesses.

If a company starts making low profits in a certain year, expenses can be analyzed. This helps identify inefficiencies and underperformance.

Asset, inventory, and receivables turnover ratios assist analysts evaluate a company’s performance.

If the company has a glut of inventory and little inventory turnover, sales are low. Poor marketing or seasonal inventory may also cause this.

Return on assets, return on equity, and earnings per share are also important. These numbers highlight firm growth and profitability issues.

Companies need liquidity ratios to determine if they can pay their loans and commitments. Horizontal analysis makes these changes easy to spot and compare to industry peers’ growth and profitability.

Example

Before continuing, let’s examine this easy example.

Every financial statement item is compared to the base year. If management compares direct sales between 2007 and 2006 (the base year), it shows a 3.2% rise.

Management would be concerned about this result. This would be investigated if they predicted a 10% increase.

Another example: an investor finds firm C. Company C’s previous-year figures: net income $2m, retained earnings $10m.

Details of the current year: net income $4m, retained earnings $12m. Retained earnings rose 20% while net income rose 100%.

The investor must now decide based on their study and comparison to similar statistics.

Horizontal Analysis criticisms

Despite its value, trend analysis is often challenged.

Analysts can use a base year with low firm performance to analyze. Thus, the current accounting period (or any other) can appear better.

Some corporations change their financial statement presentation, which complicates horizontal examination. This makes identifying problem regions and trend changes challenging.

Discussion of Horizontal Analysis

To summarize, horizontal analysis is always helpful but should not be overused. Only after considering other aspects should a decision be taken.


Leave a Reply

Your email address will not be published. Required fields are marked *