# Horizontal Analysis

Horizontal analysis is a financial review of a company’s performance over a set number of accounting periods.

## Understanding horizontal analysis

Horizontal analysis – sometimes referred to as a trend analysis – is a valuable tool for assessing a company’s financial performance over time.

It is an analytical technique that examines fluctuations in financial data across multiple reporting periods such as quarters or years. By comparing these statements, both investors and analysts can identify positive and negative trends that may impact the company’s future prospects.

The company’s operational results are clarified by balance sheets, income statements, and cash flow statements which tend to provide the clearest picture of performance. In a similar vein, critical metrics such as return on equity, profit margin, and inventory turnover identify a company’s strengths or indeed weaknesses.

Note that horizontal analyses can be absolute comparisons or percentage comparisons. In the latter, the numbers in a succeeding period are expressed as a percentage of a predetermined baseline year. This process is also known as a base-year analysis.

## Conducting horizontal analysis

Horizontal analysis can be performed in three core steps.

### 1 – Select financial statements

The first step is to select the financial statements to analyze. As noted earlier, these should span multiple reporting periods to provide a meaningful analysis.

However, while there is no stipulation that a specific interval be used, it is important to be consistent. Use month-over-month or year-over-year, but do not combine quarterly or annual statements in the same analysis

### 2 – Choose a comparison method and calculate

There are three primary comparison methods to choose from:

1. Direct comparison – where the results from one period are compared to another. These are mostly used to spot broad differences that are more obvious than others. For example, company ABC may have revenue of \$25 million in Q1 and \$33 million in Q2.
2. Variance analysisthis determines the direction of change in addition to the dollar amount in a comparison. These are most often used to study the deviation between actual company performance and forecasted or planned performance.
3. Percentage change – these are useful in larger companies where it becomes difficult to sustain the same rate of growth. Again, they can be used to determine if there have been significant deviations from forecasted or planned performance.

### 3 – Identify patterns and trends

The final step is to interpret the results of the horizontal analysis. This involves looking for trends and patterns in the financial data over time and is guided by specific questions such as “How well did each division manage the cost of goods sold (COGS) over the past four quarters?

For example, if revenue has increased steadily over the past three years, this may be a positive sign for the company’s prospects. On the other hand, if expenses have been increasing at a faster rate than revenue, this may be cause for concern.

It is important to interpret the context of the results by considering external factors such as changes in the market or the company’s strategic decisions.

## How are horizontal analyses facilitated?

The Generally Accepted Accounting Principles (GAAP) dictate corporate accounting and financial reporting in the United States.

Developed after the Great Depression, the principles were created to establish a set of standards that would facilitate accurate, transparent, and consistent financial reporting.

In the context of horizontal analysis, these principles ensure that the same accounting and reporting methods are used each year to make them comparable. Other principles dictate that a company’s financial documentation be such that it can be compared with the documentation of other companies in the same industry.

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.

## Key takeaways

• Horizontal analysis is a financial review of a company’s performance over a set number of accounting periods.
• Horizontal analysis can be performed in three core steps: select financial statements, choose a comparison method and calculate, and identify patterns and trends.
• The Generally Accepted Accounting Principles (GAAP) dictate and facilitate accurate, transparent, and consistent financial reporting in the United States. This ensures that financial reports can be compared over time and between companies in the same industry.

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Market Economy

Positive and Normative Economics

Inflation

Asymmetric Information

Autarky

Demand-Side Economics

Supply-Side Economics

Creative Destruction

Happiness Economics

Oligopsony

Animal Spirits

State Capitalism

Boom And Bust Cycle

Circular Flow Model

Market Types

Rational Choice Theory

Conflict Theory

Peer-to-Peer Economy

Knowledge-Economy

Command Economy

Labor Unions

Bottom of The Pyramid

Glocalization

Market Fragmentation

L-Shaped Recovery

Economies of Scale

Diseconomies of Scale

Economies of Scope

Price Sensitivity

Network Effects

Negative Network Effects

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