Horizontal Analysis Overview
Horizontal analysis is the comparison of historical financial information over a series of reporting periods, or of the ratios derived from this information. It is used to see if any numbers are unusually high or low in comparison to the information for bracketing periods, which may then trigger a detailed investigation of the reason for the difference. It can also be used to project the amounts of various line items into the future. The analysis is most commonly a simple grouping of information that is sorted by period, but the numbers in each succeeding period can also be expressed as a percentage of the amount in the baseline year, with the baseline amount being listed as 100%.
A common problem with horizontal analysis is that the aggregation of information in the financial statements may have changed over time, due to ongoing changes in the chart of accounts, so that revenues, expenses, assets, or liabilities may shift between different accounts and therefore appear to cause variances when comparing account balances from one period to the next.
When conducting a horizontal analysis, it is useful to conduct the analysis for all of the financial statements at the same time, so that you can see the complete impact of operational results on a company's financial condition over the review period. For example, in the two examples below, the income statement analysis shows a company having an excellent second year, but the related balance sheet analysis shows that it is having trouble funding growth, given the decline in cash, increase in accounts payable, and increase in debt.
Horizontal Analysis of the Income Statement
Horizontal analysis of the income statement is usually in a two-year format, such as the one shown below, with a variance also shown that states the difference between the two years for each line item. An alternative format is to simply 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. A third format is to include a vertical analysis of each year in the report, so that each year shows expenses as a percentage of the total revenue in that year.
|Cost of goods sold||400,000||600,000||(200,000)|
|Salaries and wages||250,000||375,000||(125,000)|
Horizontal Analysis of the Balance Sheet
Horizontal analysis of the balance sheet is also usually in a two-year format, such as the one shown below, with a variance showing the difference between the two years for each line item. 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. A less-used format is to include a vertical analysis of each year in the report, so that each year shows each line item as a percentage of the total assets in that year.
|Total current assets||600,000||880,000||280,000|
|Total current liabilities||250,000||420,000||170,000|
|Total liabilities and equity||$1,000,000||$1,680,000||$680,000|
Horizontal analysis can be misused to report skewed findings. 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. Consistent use of comparison periods can mitigate this problem.
Horizontal analysis is also known as trend analysis.