How to Perform Horizontal and Vertical Analyses of Income Statements

However, the percentage increase in sales was greater than the percentage increase in the cost of sales. Horizontal analysis of income statements also produces worthwhile information. There were rises of more than 12% in all categories of property other than transport equipment. In this report, 2019 is identified as the base year, and each line item for the other two years 2020, and 2021 is calculated as a percentage of the same line item for the base year. The horizontal analysis formula used to calculate the % base column is shown in the example below for the revenue line item. A more useful horizontal analysis can be undertaken by setting one year as the base year, and then calculating each line item for the other years as a percentage of the base year.

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• In horizontal analysis, the changes in specific financial statement values are expressed as a percentage and in U.S. dollars.
• Sometimes you may find horizontal analysis reports, saving you the calculations, but you can always calculate the percentage change yourself using publicly available financial data.
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This type of analysis is also very useful if an investor wants to determine the performance of a company prior to investing in the same. For example, an investor may want to evaluate the performance of a company over the past year– relative to the base year in order, to decide whether it is worthwhile investing in this company or not. If the comparison year is year 3, then we will input the net income of year 3 and compute the percentage change between year 3 and year 1 (base year). We’re diving into some real-life examples that’ll make horizontal analysis as easy as pie—or at least easier than understanding your phone bill. Since we do not have any further information about the segments, we will project the future sales of Colgate based on this available data.

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Horizontal analysis, also known as trend analysis, compares financial data over a specific period to identify changes and trends. The analysis compares line items from the same financial statement in different periods to identify whether there have been increases or decreases in the figures. The analysis can be conducted on both the income statement and the balance sheet, comparing the figures for multiple years or quarters. Secondly, in the second type of horizontal analysis, we are interested in knowing about the underlying trends in the line items of the income statement.

Example 1: Evaluating Profit Margins

As an alternative, vertical analysis can be carried out where each line item is calculated as a percentage of a base line item for each year. For example, in the case of the income statement, each line item might be calculated as a percentage of the revenue line. Horizontal analysis and vertical analysis are two common methods of analyzing financial statements. A horizontal analysis of Jonick’s 2018 and 2019 income statements appears above. The first two columns show income statement amounts for two consecutive years.

A business owner whose company misses targets might pivot strategy to improve in the next quarter. Similarly, an investor might decide to sell an investment to buy into a company meeting or exceeding its goals. If you don’t have a background in finance or accounting, it might seem difficult to understand the complex concepts inherent in financial documents. However, taking the time to understand financial statements, such as learning how to read an income statement, can go far in helping you advance your career. Vertical analysis, also called common-size analysis, focuses on the relative size of different line items so that you can easily compare the income statements and balance sheets of different-sized companies.

Horizontal analysis of financial statements involves comparison of a financial ratio, a benchmark, or a line item over a number of accounting periods. Horizontal analysis allows the assessment of relative changes in different items over time. It also indicates the behavior of revenues, expenses, and other line items of financial statements over the course of time.

Either way it is important to identify the reason and correct the problem as necessary. Horizontal analysis, also called time series analysis, focuses on trends and changes in numbers over time. Horizontal allows you to detect growth patterns, cyclicality, etc., and to compare these factors among different companies. In this first example, I will be doing a horizontal analysis of Company A’s revenue based on its annual income statement. Now that you know how to calculate percentage change, you can read about all the steps involved in horizontal analysis in the next section. Here, for the sake of illustration, we have shown the absolute change (in US$) and percentage change (%) of all line items in the income statement between year 1 and year 2 only.

Horizontal analysis is valuable because analysts assess past performance along with the company’s current financial position or growth. Horizontal analysis can also be used to benchmark a company with competitors in the same industry. On the other hand, horizontal analysis looks at amounts from the financial statements over a horizon of many years. Second, a variance analysis determines not only the dollar amount but the direction of change for a given general ledger account.

Another problem with horizontal analysis is that some companies change the way they present information in their financial statements. This can create difficulties in detecting troublesome areas, making it hard to spot changes in trends. Comparability means that a company’s financial statements can be compared to those of another company in the same whats the difference between a sales order and an invoice industry. An absolute comparison involves comparing the amount of the same line of the item to its amounts in the other accounting periods. For example, comparing the accounts receivables of one year to those of the previous year. Horizontal analysis makes financial data and reporting consistent per generally accepted accounting principles (GAAP).

A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. Finance Strategists has an advertising relationship with some of the companies included on this website. We may earn a commission when you click on a link or make a purchase through the links on our site. All of our content is based on objective analysis, and the opinions are our own. The investor now needs to make a decision based on their analysis of the figures, as well as a comparison to other similar figures. Consistency and comparability are generally accepted accounting principles (GAAP).