What is Horizontal Analysis?

Horizontal analysis is a process used in financial statements such as comparing line items across several years for the purpose of tracking the firms progress and historical performance. In other words, analysts use this type of analysis to compare performance metrics or accounts over a given period. They do this to see whether there is an improvement or a decline as far as the performance of the company is concerned.

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How is Horizontal Analysis Used?

Generally, horizontal analysis work is to calculate the percentage changes and amount in financial figures from one year to the other. It typically compares financial data for varied periods (months, quarters, two years, and so on). The objective for comparing is to determine the change in financial figures and the direction of those particular changes in any given company. The analysis is commonly used by internal company management and investors. Individuals who want to invest in a certain firm have to make up their minds on whether to sell their current shares or buy more. When it comes to management, it identifies which moves to make so that it can improve its company's future performance. Generally, the technique helps in understanding the performance of a business to be able to make informed decisions.

How it Works

Those who wish to invest can use horizontal analysis to determine the performance status of a company. The technique shows whether or not the company is expanding and appreciating in terms of value. Therefore, an investor can easily track a company's earnings per share ratio, using this analysis balance sheet before making an investment decision. If the analysis shows constant growth year after another, it means that there is a positive trend. So, any investor would most likely prefer to invest in the company and vise versa. When it comes to management, it is mostly concerned with the company's daily operations. So, it may want to use this technical analysis to point out areas that need improvement and that which it should maintain. For instance, the management might compare the cost of goods the company has sold and the realized profit margin over a span of either two or three years. From this, it is able to determine how the efficiency of the company in terms of performance. In other words, it gives the management a benchmark of how future performance should be and the necessary changes required in the future.

Disadvantages of Horizontal Analysis

There is a possibility of analysts making the current period to appear either good or bad. This depends on which period of accounting analysts begin from and also the number of accounting periods selected. Also, there are high chances of accurate analysis being affected by accounting charges and a one-time event. Finally, when it comes to horizontal analysis, there might have been changes in the financial statements of the informations aggregation over time. What this means is that things like assets, revenues, expenses, or liabilities may have also shifted between various accounts. So, when comparing account balances between different periods, there are likely to be variances. 

The Bottom Line 

The horizontal analysis comparison is a useful technique on its own. However, for the management and inventors to be able to make better-informed decisions an additional vertical analysis technique is necessary.