Horizontal Analysis

Horizontal analysis a type of financial analysis which involves calculating changes in financial position and performance of a company across time. Together with vertical analysis, it forms the core of the common-size analysis.

Unlike the vertical analysis which is more useful in comparing companies at a single point of time, horizontal analysis is useful when we want to know how two or more companies have done over time.

Depending on the financial statement being analyzed, horizontal analysis can be carried out in a number of ways. For example, a balance sheet horizontal analysis can be carried out by finding percentage change in each line item using the following formula:

$$ \text{Percentage Change} = \frac{\text{Recent Value} - \text{Previous Value}}{\text{Previous Value}} $$

A positive change means that the line item has increased and a negative change means it has decreased.

When analyzing more than more periods, it is often useful to divide the value for each period by the value in the beginning period.

$$ \text{Horizontal Analysis Factor} = \frac{\text{Recent Value}}{\text{Previous Value}} $$

If the value is greater than 1, it means that the line has increased, and if it is lower than 1 it means it has decreased. It is particularly useful when looking at multiple periods because it allows us to see financial position and performance at each point of time relative to the starting point of time. In multiple period analysis, percentage values might be misleading. For example, if a Company had revenue of $20 million, $18 million and $20 million in Year 1, Year 2 and Year 3, the percentage changes would be -10% and 11.11% giving an increase of a net growth of 1.11% even though there has been a net zero growth over the 3-year period.

Example

The following example shows horizontal analysis of an income statement over a single period based on percentage change method.

Year Ended Dec. 31Change
20X120X2AbsolutePercent
Sales$416,000$587,000$171,00041.1
Cost of Sales255,000328,50073,50028.8
Gross Profit161,000258,50097,50060.6
Selling Expenses42,50061,20018,70044.0
Administrative Expenses62,00084,00022,00035.5
Operating Income56,500113,30056,800100.5
Income Tax19,20040,00020,800108.3
Net Income37,30073,30036,00096.5

Horizontal analysis is useful in comparing firms across time regardless of their size because it converts financial performance to percentage or factors.

by Irfanullah Jan, ACCA and last modified on

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