Financial statements allow the business to stop in time so that entrepreneurs and investors alike can measure the fiscal performance of the company. There are various methods for examining the income statement and balance sheet. Various ratios can be used to measure profitability and asset utilization as well as historical comparison. This article looks at the horizontal analysis method for financial statement examination.
Horizontal Analysis of the Financial Statements
Horizontal analysis is a historical comparison of the financial statements. It compares financial reports from one accounting period to another. Accounting periods that are used are normally month-to-month or year-to-year. It’s known as vertical analysis because it’s like vertically laying out the reports side by side from one time period to another. Like data is then compared from each time period.
Horizontal Analysis of the Income Statement
Examining the income statement, vertical analysis is used to compare revenue categories and expense general ledger accounts in different time periods. It can also be lumped into broader categories like
- total sales
- total gross profit
- operating expense
- fixed expense
- net profit
As an example, a manager may look at total operating expense from on year to the next or make a comparison of several years. If there is a negative profit indicator, further examination may be required. The manager may look at individual operating expense accounts and compare them in the same time periods to find the root negative cause. The difference from one accounting period to another are usually expressed in percentage of change.
Horizontal Analysis of the Balance Sheet
Examining the balance sheet, horizontal analysis is used to compare historical data of assets, liabilities and owner’s equity accounts. Just like analyzing the income statement, historical data comparison of the balance sheet can be done in whole or in part. Likewise, total assets can be compared or asset categories like fixed or current asset can be compared. Also individual asset general ledger accounts can be analyzed. For example,
Current assets to current assets
or
- cash to cash
- accounts receivable to accounts receivable
- inventory to inventory
Fixed assets to fixed assets
or
- equipment to equipment
- furniture to furniture
- building to building
The same principle of horizontal analysis can be used for liabilities as well as owner’s equity.
Horizontal analysis of financial statements is an important measuring tool to determine the financial direction of the company. It’s also an important tool to help the entrepreneur find the root cause of negative trends in profitability and owner’s equity. Learn the importance of vertical analysis, another important financial analysis tool.
James Clausen - Clausen received a Bachelors Degree in Business Administration in Automotive Management and Marketing at Northwood University, graduating ...
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