Horizontal Analysis
Horizontal analysis, also known as trend analysis, is a financial analysis technique that compares financial data over a series of reporting periods. It involves calculating the percentage change for line items on financial statements from one period to the next.
This method is most commonly used to analyze trends in financial statement data over time. Each line item is listed as a percentage of another, typically the first year of the period under review, which allows for easy analysis of growth or decline.
For example, suppose you are examining the income statements of a company over three years. In a horizontal analysis, you would calculate the percentage change in revenue, costs, profits, and other line items from one year to the next.
Here’s a simplified example:
Let’s say a company’s revenue in 2021 was $1 million, and in 2022, it increased to $1.2 million. The horizontal analysis would look like this:
- From 2021 to 2022, revenue increased by $200,000 ($1.2 million – $1 million).
- As a percentage, this is a 20% increase ($200,000 / $1 million * 100%).
So, by using horizontal analysis, you can easily see the rate of growth in revenue from 2021 to 2022.
This kind of analysis is useful for spotting trends and for comparing the performance of different companies of different sizes.
Example of Horizontal Analysis
Let’s look at an example using a company’s sales revenue over a three-year period:
- In 2020, the company reported sales of $500,000.
- In 2021, sales rose to $600,000.
- In 2022, sales rose further to $720,000.
We would perform a horizontal analysis as follows:
From 2020 to 2021:
- The increase in sales is $100,000 ($600,000 – $500,000).
- This represents a 20% increase in sales ($100,000 / $500,000 x 100%).
From 2021 to 2022:
- The increase in sales is $120,000 ($720,000 – $600,000).
- This represents a 20% increase in sales ($120,000 / $600,000 x 100%).
So, the horizontal analysis shows us that the company has sustained a 20% growth rate in sales over the two-year period.
This kind of analysis helps investors and management to understand the growth rates for different line items and whether the company is improving, stagnant, or deteriorating over time. Also, it aids in identifying any unusual items or trends that may need to be investigated further.
