For example, the current period’s profits may appear excellent when only compared with those of the previous quarter but are actually quite poor if compared to the results for the same quarter in the preceding year. Horizontal analysis is used in the review of a company’s financial statements over multiple periods. The comparison between the two ratios indicates that despite the rise in both revenue and cost of sales, the gross profit has changed only marginally.
Analysis tools can help you compare companies of different sizes, companies in different industries, and the same company over time. Horizontal analysis sometimes referred to as trend analysis, is used to identify trends over a particular number of accounting periods. Further analysis via horizontal analysis will likely be required to unlock those insights, and make use of them in a strategic way.
Let’s say that in the Company ABC base year, they reported a net income of $5 million and retained earnings of $25 million. This year, Company ABC reports a net income what is a horizontal analysis of $10 million and retained earnings of $27 million. As a result, there’s a $5 million increase in net income and $2 million in retained earnings year over year.
The consistency constraint means that you have to use the same accounting methods and principles every year. So, for example, when analyzing an income statement, the first line item, sales, will be established as the base value (100%), and all other account balances below it will be expressed as a percentage of that number. Additionally, it is useful in determining how well management is using resources to run the business efficiently.
Using the financial statements, we could take the gross sales from the first quarter as our beginning period’s value. Alicia Tuovila is a certified public accountant with 7+ years of experience in financial accounting, with expertise in budget preparation, month and year-end closing, financial statement preparation and review, and financial analysis. She is an expert in personal finance and taxes, and earned her Master of Science in Accounting at University of Central Florida. These “buckets” may be further divided into individual line items, depending on a company’s policy and the granularity of its income statement. For example, revenue is often split out by product line or company division, while expenses may be broken down into procurement costs, wages, rent, and interest paid on debt.
For instance, if you run a comparative income statement for 2019 and 2020, horizontal analysis allows you to compare the revenue totals for both years to see if it increased or decreased, or remained relatively stable. If possible, you should aim to add 2018 to the mix, so you’ll be able to see if it was a trend or just a fluke. Like horizontal analysis, vertical analysis is used to mine useful insights from your financial https://www.bookstime.com/ statements. It can be applied to the same documents, but is exclusively percentile-based and travels vertically within each period across periods, rather than horizontally across periods. The process of comparing data points over time obviously requires at least two data sets to be available. You can perform horizontal analysis on any financial statement metric, financial ratio, or financial statement line item.