Definition
Horizontal analysis, also known as trend analysis, is a financial statement analysis technique that involves comparing line items over a certain period of time. It computes the percentage change of the value from the base year to the current year. This method is used to identify patterns, trends, spikes, or anomalies in the financial performance of a company over time.
Phonetic
The phonetics of the keyword “Horizontal Analysis” is /hɔːrɪˈzɒntl̩ əˈnælɪsɪs/.
Key Takeaways
- Horizontal analysis is a method of financial analysis where one item or component of financial data is compared over a sequence of reporting periods. This can provide valuable insights about a company’s growth and trends over time.
- Findings from horizontal analysis can be used to assess financial stability, performance, predict future performance or potential risk. It is a very important tool for financial analysts and investors to compare a company’s past figures and performance across time.
- Horizontal analysis can be conducted on several financial statement items like revenue, profit, earnings per share, etc. However, a limitation of horizontal analysis is that it does not consider changes in the scale of business or industry trends which could impact financial variables.
Importance
Horizontal analysis plays a vital role in business and finance because it allows businesses to compare their financial performance over a certain period. This method of financial analysis provides a detailed year-over-year understanding of the company’s growth, performance, and profitability, enabling stakeholders to see trends and make informed decisions. By comparing financial data from different periods side by side, businesses can identify any patterns, positives, negatives, or irregularities that may exist. This, in turn, aids in understanding the company’s trajectory, forecasting future performance, and formulating business strategies. Hence, horizontal analysis is a vital tool in financial management.
Explanation
Horizontal Analysis, often referred to as trend analysis, is an essential method of financial statement examination employed by businesses and financial analysts. Its primary purpose is to assist stakeholders in understanding the relative changes in different line items over time. This kind of analysis is used to evaluate financial data over a specific period, often a few years, enabling users to identify trends, make predictions, and form strategies accordingly. Horizontal analysis is invaluable when it comes to understanding the growth patterns of a business, determining both gains and losses on the income statement, and ascertaining any significant changes in a company’s financial standing.The utility of horizontal analysis extends to allowing businesses to make efficient investment decisions, assess risks and returns, and perform meaningful company-to-company comparisons. By expressing the change of data as a percentage, relative relationships concerning corresponding financial statement accounts over a defined period are discernable. For example, a business can utilize horizontal analysis to discover that their cost of goods sold or their administrative costs have gradually increased as a percentage of sales over the past few years. These insights might prompt a company to dive deeper into these areas to identify causative issues, hence helping it to make informed financial and operational decisions.
Examples
1. Coca-Cola Company Analysis: The financial report of Coca-Cola Company was analyzed for the years 2015 and 2016. After the horizontal analysis, it was clear that there was a decrease in their net operating revenue by 5%. This is significant information for investors, as this demonstrates that the company’s revenue stream was weaker in 2016 compared to 2015.2. Amazon Inc. Analysis: In 2019, Amazon’s report showed a considerable increase in their net sales over the course of five years using horizontal analysis. In 2015, their net sales were near $107 billion, while in 2019, they increased to nearly $280 billion. This significant growth over the years, revealed by horizontal analysis, points to a promising trend in Amazon’s growth and profitability.3. Ford Motor Company Analysis: While performing the horizontal analysis for Ford Motor Company, from 2017 to 2018, it was found that their total assets decreased from $256 billion to $252 billion a 1.5% decrease. This decrease may signal a negative trend and should be further investigated by potential investors or current shareholders.
Frequently Asked Questions(FAQ)
What is Horizontal Analysis?
Horizontal Analysis is a method used in financial statement analysis where the comparative performance of line items is analyzed over a period of time. This analysis helps identify trends and growth patterns in the performance of a company.
How is Horizontal Analysis conducted?
Horizontal Analysis is conducted by using the financial data from a company’s financial statement over a certain period and comparing the percentage change year over year.
What is the main purpose of Horizontal Analysis?
The main purpose of Horizontal Analysis is to give a clear picture of the performance trend over time. It helps in identifying areas, where the performance has improved or deteriorated over the years, which is important in decision making.
How does Horizontal Analysis differ from Vertical Analysis?
While Horizontal Analysis compares performance over different accounting periods, Vertical Analysis entails reviewing and evaluating a single financial statement period. Vertical Analysis reflects the proportional value for each category of accounts on the balance sheet and income statement, presenting each as a percentage of total numbers.
What is the base year in Horizontal Analysis?
The base year in Horizontal Analysis is typically the first year of comparison. Figures from this year are used as a basis for measuring performance in subsequent years.
Which financial statements can be analyzed using Horizontal Analysis?
Horizontal Analysis can be used to evaluate any financial statement, including the income statement, balance sheet, and cash flow statement.
What is the advantage of using Horizontal Analysis in financial statement analysis?
Horizontal Analysis is beneficial in identifying trends in business performance and financial health over time. This can influence strategic decision-making for continuing successful initiatives or addressing areas of weakness.
Is Horizontal Analysis used in business ratios calculation?
Yes, Horizontal Analysis is often used in the calculation of business ratios. It can help to determine trends in profitability, liquidity, and solvency ratios.
Can Horizontal Analysis identify inconsistencies in financial data?
Yes, Horizontal Analysis can be beneficial in detecting inconsistencies, irregularities or any unusual items in the financial statements.
Related Finance Terms
- Base Year
- Trend Analysis
- Financial Statement Comparison
- Percentage Change
- Period-on-Period Analysis
Sources for More Information
