Horizontal Analysis

Introduction

When it comes to analyzing financial statements, businesses have several tools at their disposal. One such tool is horizontal analysis, which allows companies to compare financial data over a period of time. By examining trends and changes in key financial metrics, businesses can gain valuable insights into their performance and make informed decisions. In this article, we will explore the concept of horizontal analysis, its benefits, and how it can be applied in real-world scenarios.

What is Horizontal Analysis?

Horizontal analysis, also known as trend analysis, is a technique used to evaluate financial statements by comparing data from different periods. It involves analyzing the percentage changes in line items over time to identify trends, patterns, and anomalies. By examining these changes, businesses can gain a deeper understanding of their financial performance and make strategic decisions accordingly.

Example:

Let's consider a hypothetical company, ABC Corp., which wants to assess its revenue growth over the past three years. By conducting a horizontal analysis of its income statement, ABC Corp. can compare the revenue figures for each year and calculate the percentage change. This analysis will help the company identify whether its revenue is increasing, decreasing, or remaining stable over time.

The Benefits of Horizontal Analysis

Horizontal analysis offers several benefits to businesses, enabling them to make informed decisions and improve their financial performance. Some of the key advantages include:

• Identifying trends: Horizontal analysis allows businesses to identify trends in their financial data. By comparing line items over time, companies can spot patterns and understand whether their performance is improving or declining.
• Highlighting anomalies: This analysis can help businesses identify any unusual fluctuations or anomalies in their financial statements. These anomalies may indicate errors, fraud, or other issues that require further investigation.
• Assessing financial health: By examining key financial metrics, such as revenue, expenses, and profitability, businesses can assess their overall financial health. This analysis provides insights into the company's ability to generate profits, manage costs, and meet its financial obligations.
• Comparing performance: Horizontal analysis allows businesses to compare their performance with industry benchmarks or competitors. By benchmarking against others in the same industry, companies can identify areas where they are lagging and take corrective actions.

Applying Horizontal Analysis

Horizontal analysis can be applied to various financial statements, including the income statement, balance sheet, and cash flow statement. Let's explore how this analysis can be used in each of these statements:

Income Statement:

Horizontal analysis of the income statement involves comparing revenue, expenses, and profitability metrics over time. By analyzing these line items, businesses can gain insights into their revenue growth, cost management, and overall profitability trends.

Balance Sheet:

When conducting horizontal analysis on the balance sheet, businesses can compare assets, liabilities, and equity over different periods. This analysis helps companies understand their liquidity, solvency, and capital structure changes over time.

Cash Flow Statement:

Horizontal analysis of the cash flow statement involves examining the cash inflows and outflows over a period of time. By analyzing these changes, businesses can assess their ability to generate cash, manage working capital, and meet their financial obligations.

Real-World Example: Apple Inc.

Let's take a look at a real-world example of horizontal analysis using the financial statements of Apple Inc., one of the world's leading technology companies.

In Apple's income statement for the fiscal year 2020, we can observe the following revenue figures:

• FY 2020: $274.52 billion
• FY 2019: $260.17 billion
• FY 2018: $265.60 billion

By calculating the percentage change in revenue for each year, we can analyze the trend:

• FY 2020 to FY 2019: (274.52 – 260.17) / 260.17 = 5.52%
• FY 2019 to FY 2018: (260.17 – 265.60) / 265.60 = -2.04%

From this analysis, we can see that Apple's revenue increased by 5.52% from FY 2019 to FY 2020, indicating growth. However, there was a decline of 2.04% in revenue from FY 2018 to FY 2019.

Conclusion

Horizontal analysis is a powerful tool that allows businesses to gain insights into their financial performance over time. By comparing financial data from different periods, companies can identify trends, anomalies, and areas for improvement. This analysis helps businesses make informed decisions, assess their financial health, and benchmark their performance against industry standards. By incorporating horizontal analysis into their financial analysis toolkit, businesses can enhance their decision-making processes and drive sustainable growth.