How to Perform Horizontal and Vertical Analyses of Income Statements

In our course on Analysisof Financial Statements, we explore all the above metrics and ratios in great detail. For the below example, revenue in Year 3 was $55,749, and in Year 2, it was $53,494. The YoY change in revenue is equal to $55,749 / $53,494 minus one, which equals 4.2%. In order to perform this exercise, you need to take the value in Period N and divide it by the value in Period N-1 and then subtract 1 from that number to get the percent change. Structured Query Language is a specialized programming language designed for interacting with a database….

• You do not need special financial skills to ascertain the difference between previous and last year’s data.
• The USD 552.6 million expense in 2009 was the result of a provision for restructured operations.
• For example, if a company starts generating low profits in a particular year, expenses can be analyzed for that year.
• We need to perform a horizontal analysis of the income statement of this company.
• It is most valuable to do horizontal analysis for information over multiple periods to see how change is occurring for each line item.

To calculate 2014, we DO NOT go back to the baseline to do the calculations; instead, 2013 becomes the new baseline so that we can see percentage growth from year-to-year. By identifying a problem, businesses can then devise a strategy to cope with it. The key to analysis is to identify potential problems provide the necessary data to legitimize change. For instance, a large increase in Sales returns and allowances coupled with a decrease in Sales over two years would be cause for concern. If this is the case, you need to address and solve the problem or the company’s reputation and future may be at stake.

Comparative Balance Sheets With Horizontal Analysis

This increase in capital expenditures is also reflected on the liability side of the balance sheet. Peggy James is a CPA with over 9 years of experience in accounting and finance, including corporate, nonprofit, and personal finance environments. She most recently worked at Duke University and is the owner of Peggy James, CPA, PLLC, serving small businesses, nonprofits, solopreneurs, freelancers, and individuals. From that comparative statement, you highlight increases or decreases within that time frame.

• They can use them externally to examine potential investments and the creditworthiness of borrowers, amongst other things.
• You use horizontal analysis to find and monitor trends over a period of time.
• The cash flow statement will help us understand the inflows and outflows of cash over the time period we’re looking at.
• The ability to spot this trend over time empowers you to intervene and be pro-active in solving the problem.
• Ratios such as asset turnover, inventory turnover, and receivables turnover are also important because they help analysts to fully gauge the performance of a business.

This usually begins with the income statement but also includes the balance sheet and cash flow statement. 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 may have been rising because the cost of goods sold has been falling or because sales have been growing steadily. Coverage ratios, like the cash flow-to-debt ratio and the interest coverage ratio, can reveal how well a company can service its debt through sufficient liquidity and whether that ability is increasing or decreasing. Horizontal analysis also makes it easier to compare growth rates and profitability among multiple companies in the same industry.

Balance Sheet and Leverage Ratios

This fact indicates that the company will be able to pay its debts as they come due. All items on the balance sheet and income statement for the year 2008 have been compared with the items of balance sheet and income statement for the year 2007. Financial analysis of an income statement can reveal that the costs of goods sold are falling, or that sales have been improving, while return on equity is rising. Income statements are also carefully reviewed when a business wants to cut spending or determine strategies for growth. This type of analysis makes it simple to compare financial statements across periods and industries, and between companies, because you can see relative proportions.

Horizontal analysis is the use of financial information over time to compare specific data between periods to spot trends. This can be useful because it allows you to make comparisons across different sets of numbers. How detailed your https://www.bookstime.com/ initial financial statements are depends largely on the accounting software application you’re using. If you’re using an entry-level application, it’s likely you’ll need to use spreadsheets in order to complete the horizontal analysis.

How Horizontal Analysis Works

First, we need to take the previous year as the base year and last year as the comparison year. As we see, we can correctly identify the trends and develop relevant areas to target for further analysis. We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone horizontal analysis and have not been previously reviewed, approved, or endorsed by included advertisers. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team. Investopedia requires writers to use primary sources to support their work.

Horizontal, or trend, analysis is used to spot and evaluate trends over a specific period of time. Financial statements are written records that convey the business activities and the financial performance of a company. Horizontal analysis can be manipulated to make the current period look better if specific historical periods of poor performance are chosen as a comparison. The comparability constraint dictates that your statements and documents need to be evaluated against companies similar to yours within the same industry. Horizontal analysis improves and enhances the constraints during financial reporting.

Horizontal Analysis: Should You Be Using It in Your Business?

Within an income statement, you’ll find all revenue and expense accounts for a set period. Accountants create income statements using trial balances from any two points in time. The purpose of an income statement is to show a company’s financial performance over a period. If you don’t have a background in finance or accounting, it might seem difficult to understand the complex concepts inherent in financial documents. But taking the time to learn about financial statements, such as an income statement, can go far in helping you advance your career.

• Recall that horizontal analysis calculates changes in comparative statement items or totals, whereas vertical analysis consists of a comparison of items on a single financial statement.
• To illustrate, consider an investor who wishes to determine Company ABC’s performance over the past year before investing.
• For example, in Safeway Stores’ balance sheets, both sales and the cost of sales increased from 2018 to 2019.
• The investor now needs to make a decision based on their analysis of the figures, as well as a comparison to other similar figures.
• Therefore, total net sales are the Oral, Personal & Home Care, andPet Nutrition Segment.