Unusual changes, such as a large increase in accounts receivable without a corresponding increase in sales, warrant further investigation as they might point to issues like slow collections. Gathering and organizing financial data is a horizontal analysis accounting foundational step for horizontal analysis. This process starts with obtaining the relevant financial statements for the periods you intend to compare. For instance, collect Income Statements for two consecutive fiscal years, or a longer series of annual reports to observe multi-year trends. This analysis applies to core financial statements, including the Income Statement, Balance Sheet, and Cash Flow Statement.
A. Financial Performance Evaluation
The most significant insight that percentage change analysis provides is the identification of growth or decline rates in financial metrics such as revenue, expenditures, and profits. Investigation and remedial measures could turn out necessary in response to declining rates. By employing the same methodology on other accounts, it is possible to determine whether their percentage increases or decreases in comparison to the base year. From 2023 to 2024, Reliance Industries’ revenue increased by Rs.1,00,000 crores, or 20%.
- For example, let’s say Reliance Industries had revenue of Rs.5,00,000 crores in 2023 (base year) and revenue of Rs.6,00,000 crores in 2024 (current year).
- For example, an increase of 10% in a line item’s revenues might seem insignificant but could represent a substantial absolute increase or decrease depending on the base year and the total revenue size.
- This analysis helps stakeholders assess a company’s progress over time and make informed financial decisions.
Future Trends
All of the amounts on the balance sheets and the income statements will be expressed as a percentage of the base year amounts. The amounts from the most recent years will be divided by the base year amounts. For instance, if a most recent year amount was three times as large as the base year, the most recent year will be presented as 300. If the previous year’s amount was twice the amount of the base year, it will be presented as 200.
Lita Epstein, who earned her MBA from Emory University’s Goizueta Business School, enjoys helping people develop good financial, investing, and tax planning skills. She designs and teaches online courses and has written more than 20 books, including Bookkeeping For Dummies and Reading Financial Reports For Dummies, both published by Wiley. When revenue grows 15% but COGS increases 20%, you’re looking at margin compression that demands immediate attention. The 50% still represents a positive outcome from 2018 even though it still represents an overall decline in the growth of revenue. Here are the straightforward steps which prove not to be as difficult as some other analytic accounting processes.
Manufacturing Cost Structure Evolution
- In this report, 2019 is identified as the base year, and each line item for the other two years 2020, and 2021 is calculated as a percentage of the same line item for the base year.
- Smart finance teams analyze revenue alongside working capital changes to understand whether growth is generating cash or consuming it.
- The process of comparing data points over time obviously requires at least two data sets to be available.
- This method helps in evaluating how specific financial statement items have evolved, providing insights into a business’s operational effectiveness and strategic direction.
- The concept emerged from the need to track financial metrics across reporting periods to spot variances and identify performance patterns.
The subsequent periods, known as current periods, are then compared against this established baseline. This consistent reference point allows for a clear tracking of changes over time. Lastly, GAAP ensure that financial statements are presented in a way that is easier to read and comprehend. This allows investors and other interested parties to identify the factors that drive a company’s growth, determine any trends, and make forecasts. As noted earlier, these should span multiple reporting periods to provide a meaningful analysis.
Horizontal and Vertical Analysis
In the same way, the absolute change is as described below if the cost of products sold was Rs. 60,000 in 2019 and Rs. 90,000 in 2020. For example, let’s say Reliance Industries had revenue of Rs.5,00,000 crores in 2023 (base year) and revenue of Rs.6,00,000 crores in 2024 (current year). In conclusion, we’re able to compare the year-over-year (YoY) performance of our company from 2020 to 2021. The priority here should be to identify the company’s areas of strengths and weaknesses to create an actionable plan to drive value creation and implement operating improvements. The latter two tend to go hand-in-hand because the most useful benchmark against which to compare recent performance is most often the preceding period. The accounting period covered could be one-month, a quarter, or a full fiscal year.
In this report, 2019 is identified as the base year, and each line item for the other two years 2020, and 2021 is calculated as a percentage of the same line item for the base year. The horizontal analysis formula used to calculate the % base column is shown in the example below for the revenue line item. The presentation of the changes from year to year for each line item can be analyzed to see where positive progress is occurring over time, such as increases in revenue and profit and decreases in cost. Conversely, less favorable readings may be isolated using this approach and investigated further. There are three main methods used for making comparisons in horizontal analysis – direct comparison, variance analysis, and percentage method. New asset investments are sometimes an indication of an increase in expenditure.
Income statements and balance sheets are the primary financial statements that are necessary for horizontal analysis. The income statement summarises a company’s revenues, expenses, and net profit or loss over a specified period, typically one year. Generally, horizontal analysis work is to calculate the percentage changes and amount in financial figures from one year to the other. It typically compares financial data for varied periods (months, quarters, two years, and so on). The objective for comparing is to determine the change in financial figures and the direction of those particular changes in any given company.
For example, if comparing 2023 and 2024 data, 2023 would commonly be chosen as the base year. Another advantage is that horizontal analysis emphasises outliers and unusual fluctuations. The percentages are particularly noticeable when an account experiences an abrupt up or down Swing.
Horizontal or trend analysis of financial statements
Let us dive deeper into the importance of consistency in horizontal analysis and how it impacts financial statement analysis. Although changes in accounting policies or one-time events can impact horizontal analysis, these situations should be disclosed in the footnotes to the financial statements to maintain consistency. Gathering Financial InformationThe first step in performing a horizontal analysis is to collect the financial information for the accounting periods under review. To ensure consistency and comparability, make sure that you have annual or quarterly financial statements with equal intervals between each statement.