Master the Horizontal Analysis Formula For Stock Investing

horizontal analysis formula

Using this type of analysis helps you can determine whether certain financial metrics like gross profit have increased or decreased over time. Analysts must perform horizontal analysis of all major financial statements as key financial metrics are closely linked for all of them. Many companies do not split credit and cash sales, in which case net sales would be used to compute accounts receivable turnover. Average accounts receivable is found by dividing the sum of beginning and ending accounts receivable balances found on the balance sheet. The beginning accounts receivable balance in the current year is taken from the ending accounts receivable balance in the prior year. Using the formula described above, calculate the horizontal analysis formula for each item you selected.

horizontal analysis formula

Finally, it is important to compare the horizontal analysis results with industry averages, as well as with the company’s competitors. This will help you determine whether the company is performing better or worse than its peers in similar industries and provide you with a more complete picture of its financial performance. In addition, for different companies, you may want to look at additional financial items.

What is horizontal analysis?

This means Banyan Goods saw an increase of $20,000 in net sales in the current year as compared to the prior year, which was a 20% increase. The image below shows the complete horizontal analysis of the income statement and balance sheet for Banyan Goods. Horizontal analysis, also known as trend analysis, involves the comparison of financial statement data across multiple periods to identify trends, patterns, and changes. By examining year-to-year changes in key financial metrics, you can gain insights into a company’s growth, stability, and overall performance. The term “Horizontal Analysis” refers to the method of analyzing financial statements where historical data from the income statement, balance sheet, and cash flow statement are subject to comparison. This comparison shows how each line item has changed in absolute terms or as a percentage change year over year (Y-o-Y).

Calculating this involves subtracting the base period’s value from the comparison period‘s value, dividing the result by the base period’s value, then multiplying by 100. On the other hand, vertical analysis offers a snapshot, a deep dive into the structural composition of financial statements at a particular moment. For example, if management determines that increased earnings per share are due to an increase in revenue or a drop in the cost of goods sold (COGS), the horizontal analysis can corroborate. It’s best to do so for all of the financial statements at once so you can understand the full influence of operational outcomes on a company’s financial situation across the review period.

How to perform horizontal analysis

In percentage comparison, the increase or decrease in amounts is expressed as a percentage of the amount in the base year. Nonetheless, continuous comparisons and the implementation of additional horizontal analysis formula financial analysis techniques help to take care of this drawback. Rather than comparing revenues from 2019, Horizontal Analysis still compares the revenues of 2020 to 2018 (the base year).

horizontal analysis formula

Liquidity ratios are needed to check if the company is liquid enough to settle its debts and pay back any liabilities. Horizontal analysis makes it easy to detect these changes and compare growth rates and profitability with other companies in the industry. As seen from the above example, every ratio is given in relation to the revenue in the case of income statement.

Horizontal vs Vertical Trend Analysis

Horizontal analysis is most useful when an entity has been established, has strong record-keeping capabilities, and has traceable bits of historical information that can be dug into for more information as needed. This type of analysis is more specific relevant for analyzing the value we maybe selling or acquiring. Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more. Problem-solving abilities enable you to determine why something is occurring and how to resolve it.

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