Horizontal Analysis: Should You Be Using It in Your Business?

Horizontal Analysis: Should You Be Using It in Your Business?

Average total assets are found by dividing the sum of beginning and ending total assets balances found on the balance sheet. The beginning total assets balance in the current year is taken from the ending total assets balance in the prior year. Nonetheless, vertical analysis possesses its own advantages in your company’s accounting operations. It means the changes are shown as a percentage of a base item in the statement and there are no representations for variance. Another way to see this is where the base period was unusually poor, taking the year 2020 which was greatly affected by the COVID pandemic for example.

This example demonstrates how horizontal analysis of cash flow statements can provide insights into a company’s cash management, liquidity, and financial stability. Liquidity ratios show the ability of the company to pay short-term obligations if they came due immediately with assets that can be quickly converted to cash. Lenders, for example, may consider horizontal analysis formula the outcomes of liquidity ratios when deciding whether to extend a loan to a company. A company would like to be liquid enough to manage any currently due obligations but not too liquid where they may not be effectively investing in growth opportunities. Three common liquidity measurements are working capital, current ratio, and quick ratio.

Formulas for horizontal analysis

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 is performed by placing multiple years’ worth of data lined up next to each other and then graphing the data points to determine if there is a trend, and where it is going.

• Conversely, negative trends like declining revenues or increasing costs require attention to prevent further deterioration.
• The more popular financial statements over which Horizontal Analysis is executed are the income statement and balance sheet.
• Suppose we’re tasked with performing a horizontal analysis on a company’s financial performance from fiscal years ending in 2020 to 2021.
• By leveraging the insights gained from horizontal analysis, businesses can make informed decisions, mitigate risks, and drive sustainable growth.
• If inflation has influenced the financial data, it is essential to adjust the figures to account for its impact.

Let’s illustrate the application of these advanced techniques with an example. Imagine you’re analyzing Company DEF’s financial data for 2022 and 2023, and you want to use rolling averages, regression analysis, and industry benchmarking to gain deeper insights. Evaluate the size of the changes relative to the company’s size, industry benchmarks, and historical performance. Smaller variations may be within an acceptable range, while larger variations may require further investigation. Carefully examine the percentage changes to understand the magnitude and significance of variations. Look for major fluctuations that may indicate critical events or shifts in the company’s operations.

Part 2: Your Current Nest Egg

You’ll need to speak with the accounting department to determine what assets were purchased in Year 2. The ideal number is 1 or higher, where a company can completely meet its current liabilities with its current assets, but, depending on the industry, a lower number might be the norm. A horizontal analysis of the trends in solvency ratios will reveal if the company is increasingly insolvent or stably solvent. Now that you have the percentage change values for your chosen variables – both for your company and others in the same industry – it’s time to analyze your company’s values and those of your competitors. This will allow you to interpret these results within as comprehensive a context as possible. Now that you know how to calculate percentage change, you can read about all the steps involved in horizontal analysis in the next section.