Financial Planning and Analysis

How to Perform Horizontal Analysis of Financial Statements

Uncover vital financial trends and assess a company's evolving performance with horizontal analysis.

Horizontal analysis is a financial analytical technique used to compare financial information across different reporting periods. It is also known as trend analysis, as its primary purpose is to identify patterns and changes in a company’s financial performance or position over time. This method helps in evaluating how specific financial statement items have evolved, providing insights into a business’s operational effectiveness and strategic direction. By examining data from successive periods, horizontal analysis reveals the growth or decline of various accounts.

Selecting Financial Data

Financial statements must be prepared for at least two periods. While two periods allow a basic comparison, using data from three or more accounting periods provides a more robust foundation for identifying meaningful trends. The primary financial statements used include the comparative Income Statement, the comparative Balance Sheet, and the comparative Cash Flow Statement. These statements present financial figures side-by-side for easy comparison across the chosen periods.

A “base period” serves as the reference point for all subsequent comparisons. This base period is usually the earliest year or period included in the analysis. For instance, if analyzing data from 2022, 2023, and 2024, 2022 would be the base period. All changes, both absolute and percentage, are then measured against the figures reported in this base period. Consistency in accounting principles is important across all periods to ensure that the financial data is truly comparable.

Calculating Period-to-Period Changes

After selecting financial statements and establishing a base period, calculate the absolute and percentage changes for each line item. These computations help quantify the extent of movement in each account over time.

The absolute change for any line item is determined by subtracting its value in the base period from its value in the current period. For example, if a company’s revenue was $500,000 in the base year and $600,000 in the current year, the absolute change would be $100,000. This calculation provides the direct dollar increase or decrease for each item, such as Cash, Accounts Receivable, or Sales Revenue.

The percentage change offers a standardized way to compare the magnitude of change across different line items, regardless of their absolute values. It is calculated by dividing the absolute change by the base period value and then multiplying the result by 100. Using the previous revenue example, the percentage change would be ($100,000 / $500,000) 100, resulting in a 20% increase. This allows for a relative comparison that highlights the proportional impact of changes.

For a line item like Cost of Goods Sold (COGS), if it was $300,000 in the base year and $330,000 in the current year, the absolute change is $30,000. The percentage change would be ($30,000 / $300,000) 100, or a 10% increase. Similarly, if Accounts Payable decreased from $80,000 to $72,000, the absolute change is -$8,000, and the percentage change is (-$8,000 / $80,000) 100, or a -10% decrease. Performing these calculations for every relevant account on the financial statements provides a comprehensive view of period-to-period variations.

Analyzing Trend Information

After calculating changes, interpret the results to understand underlying trends. This analysis focuses on identifying significant increases or decreases and what these movements suggest about a company’s performance and financial health. Looking for consistent patterns or unusual fluctuations is a core aspect of this stage.

Consistent revenue growth over several periods, for example, suggests expanding business operations and increasing market demand for products or services. Conversely, a sustained increase in expenses relative to sales could signal declining efficiency or rising operational costs that might impact profitability. An increase in accounts receivable might indicate issues with collecting payments from customers, prompting further investigation into credit policies or collection efforts.

Horizontal analysis helps detect financial issues by highlighting items that deviate from historical norms. For instance, a disproportionate increase in selling, general, and administrative (SG&A) expenses compared to revenue growth could indicate inefficiencies or new investments that have yet to yield returns. This method also identifies seasonal patterns, such as revenue spikes during holiday seasons or increased inventory levels in anticipation of higher demand. The insights gained from these trends are valuable for making informed management decisions, improving financial forecasting, and supporting budgeting processes.

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