Horizontal Analysis

What Is Horizontal Analysis?

 Horizontal analysis is used in financial statement
analysis to compare historical data, such as ratios,
or line items, over a number of accounting periods.
Horizontal analysis can either use absolute
comparisons or percentage comparisons, where
the numbers in each succeeding period are
expressed as a percentage of the amount in
the baseline year, with the baseline amount being
listed as 100%. This is also known as base-year
analysis.
KEY TAKEAWAYS
• Horizontal analysis is used in the review of a
company's financial statements over multiple
periods.
• It is usually depicted as a percentage growth over
the same line item in the base year.
• Horizontal analysis allows financial statement
users to easily spot trends and growth patterns.
• It can be manipulated to make the current period
look better if specific historical periods of poor
performance are chosen as a comparison.
How Horizontal Analysis Is Used
 Generally accepted accounting principles (GAAP) are
based on consistency and comparability of financial
statements. Consistency is the ability to accurately
review one company's financial statements over a
period of time because accounting methods and
applications remain constant. Comparability is the ability
to review side-by-side two or more different companies'
financials. Horizontal analysis not only improves the
review of a company's consistency over time directly,
but it also improves comparability of growth in a
company to that of its competitors as well.
 Horizontal analysis allows investors and analysts to
see what has been driving a company's financial
performance over a number of years, as well as to
spot trends and growth patterns such
as seasonality. It enables analysts to assess relative
changes in different line items over time, and project
them into the future. By looking at the income
statement, balance sheet, and cash flow
statement over time, one can create a complete
picture of operational results, and see what has
been driving a company’s performance and whether
it is operating efficiently and profitably.
 The analysis of critical measures of business
performance, such as profit margins, inventory
turnover, and return on equity, can detect emerging
problems and strengths. For example, earnings per
share (EPS) may have been rising because the cost
of goods sold (COGS) have been falling, or because
sales have been growing strongly. And coverage
ratios, like the cash flow-to-debt ratio and the interest
coverage ratio can reveal whether a company can
service its debt through sufficient liquidity. Horizontal
analysis also makes it easier to compare growth rates
and profitability among multiple companies.
For example, assume an investor wishes to invest in
company JBG. The investor may wish to determine how the
company grew over the past year. Assume that in company
JBG's base year, it reported net income of P10 million and
retained earnings of P50 million. In the current year,
company JBG reported net income of P20 million and
retained earnings of P52 million. Consequently, it has an
increase of P10 million in its net income and P2 million in its
retained earnings year over year. Therefore, company JBG's
net income grew by 100% ((P20 million - P10 million) / P10
million * 100) year over year, while its retained earnings only
grew by 4% ((P52 million - P50 million) / P50 million * 100).
Criticism of Horizontal Analysis
 Depending on which accounting period an
analyst starts from and how many accounting
periods are chosen, the current period can be
made to appear unusually good or bad. For
example, the current period's profits may
appear excellent when only compared with
those of the previous quarter, but are actually
quite poor if compared to the results for the
same quarter in the preceding year.
A common problem with horizontal analysis is that
the aggregation of information in the financial
statements may have changed over time, 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. Indeed, sometimes
companies change the way they break down their
business segments to make the horizontal analysis
of growth and profitability trends more difficult to
detect. Accurate analysis can be affected by one-off
events and accounting charges.
Vertical Analysis vs. Horizontal Analysis
 While horizontal analysis looks changes in the dollar
amounts in a company’s financial statements over
time, vertical analysis looks at each line item as a
percentage of a base figure within the current period.
Thus, line items on an income statement can be stated as
a percentage of gross sales, while line items on a balance
sheet can be stated as a percentage of total assets or
liabilities, and vertical analysis of a cash flow statement
shows each cash inflow or outflow as a percentage of the
total cash inflows. Vertical analysis is also known
as common size financial statement analysis. (For more,
read The Common-Size Analysis of Financial
Statements.)