Horizontal Analysis

What is Horizontal Analysis?

Based on historical data, a horizontal analysis interprets the change in financial statements over two or more accounting periods. It denotes the percentage change in the same line item of the next accounting period compared to the value of the baseline accounting period.

Understanding Horizontal Analysis

The horizontal analysis evaluates trends Year over Year (YoY) or Quarter over Quarter (QoQ). If you are an investor considering investing in a company, only a year-end balance sheet or income statement would not be enough to judge how a company is doing. It would help if you looked at a couple of years to be sure. Better yet, you can see many years of balance sheets and income statements and compare them.

Through horizontal analysis of financial statements, you would be able to see two actual data for consecutive years and would be able to compare every item. And based on that, you can forecast the future and understand the trend.

You do not need special financial skills to ascertain the difference between the previous and last year’s data. However, it would be best if you had diligence, attention to detail, and a logical mind to decipher why the change happens.

In this GKSR example above, we can identify the YoY growth rate using a horizontal income statement analysis. In addition, it helps us identify potential areas of growth and concerns.

For example, in GKSR, we note that the provision for income tax has increased by 12.6%. However, revenues have increased by only 5.5%. Why did provisions increase at a higher rate? Also, there has been a comparatively higher growth of 9.1% in selling and admin costs. What could have contributed to this increase?

As we see, we can correctly identify the trends and develop relevant areas to target for further analysis.

Horizontal Analysis Explained in Video

Horizontal Analysis Formula

First, we need to take the previous year as the base year and the last year as the comparison year. So, for example, let us say we are comparing 2015 and 2016. We will take 2015 as the base year and 2016 as the comparison year.

Horizontal Analysis formula = [(Amount in Comparison Year – Amount in the Base Year)/ Amount in a Base Year] x 100

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For eg:
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Horizontal Analysis Example

Let us assume that we are provided with the income statement data of ABC Co. We need to perform a horizontal analysis of the income statement of this company.

Details	2016 (In US $)	2015 (In US $)	Amount	Percentage
Sales	30,00,000	28,00,000	200,000 *	7.14% **
(-) Cost of Goods Sold(COGS)	(21,00,000)	(20,00,000)	100,000	5%
Gross Profit	900,000	800,000	100,000	12.50%
General Expenses	180,000	120,000	60,000	50%
Selling Expenses	220,000	230,000	(10,000)	(4.35%)
Total Operating Expenses	(400,000)	(350,000)	50,000	14.29%
Operating Income	500,000	450,000	50,000	11.11%
Interest expenses	(50,000)	(50,000)	§	§
Profit before Income Tax	450,000	400,000	50,000	12.50%
Income Tax	(125,000)	(100,000)	25,000	25%
Net Income	325,000	300,000	25,000	8.33%

The following is a basic example of dividing our approach into two parts. First, we found the absolute difference between the comparative years.

• For example, change in sales = (30,00,000 – 28,00,000) = 200,000
• We find the percentage changePercentage ChangePercentage Change can be defined as a % change in value due to changes in the old number and new number and the values can either increase or decrease and so the change can be a positive value (+) or a negative value (-). read more = 200,000/28,00,000 * 100 = 7.14%.

Likewise, we can do the same for all the other entries in the income statement.

Colgate Horizontal Analysis

Let us now look at the horizontal analysis of Colgate’s income statement. First, Colgate’s income statement’s YoY growth rates from 2008 until 2015. Then, we calculate the growth rate of each of the line items concerning the previous year.

For example, to find the growth rate of net sales for 2015, the formula is (Net Sales 2015 – Net Sales 2014) / Net Sales 2014.

Here are the following observations from Colgate: –

• Colgate has seen a dip in net sales figures in the last two years. In 2015, Colgate saw a de-growth of -7.2%. Why?
• The cost of sales Cost Of SalesThe costs directly attributable to the production of the goods that are sold in the firm or organization are referred to as the cost of sales.read more has decreased (positive from the company’s point of view). Why is this so?
• Net income fell in the last three years, with a 36.5% decline in 2015.

Uses in Financial Modeling

Horizontal analysis is very useful for Financial Modeling and ForecastingFinancial Modeling And ForecastingFinancial modeling refers to the use of excel-based models to reflect a company's projected financial performance. Such models represent the financial situation by taking into account risks and future assumptions, which are critical for making significant decisions in the future, such as raising capital or valuing a business, and interpreting their impact.read more. The approach used here is pretty simple.

• Step 1 – Perform the horizontal analysis of the income statement and balance sheet historical data.
• Step 2 – You can assume future growth rates based on the YoY or QoQ growth rates.

Let us now look at Colgate 10K 2013 report. First, we noted that Colgate had not provided segmental information in the income statement. However, as additional information, Colgate has provided some details of segments on page 87. 

Source – Colgate 2013 – 10K, Page 86

Since we do not have any further information about the segments, we will project the future sales of Colgate based on this available data. We will use the sales growth approach across segments to derive the forecasts. Please see the picture below. We have calculated the Year-over-Year growth rate for each segment.

Now we can assume a sales growth percentage based on the historical trends and project the revenues under each segment. Therefore, total net sales are in the Oral, Personal & Home Care, and Pet Nutrition Segments. 

Frequently Asked Questions (FAQs)

Recommended Articles

This article is a guide to Horizontal Analysis. We discuss the formula of horizontal analysis on the income statement and balance sheet with examples. You may go through the following articles for further readings on financial analysis: –

• Examples of Horizontal Merger
• Components of Financial Statements
• Operating Income Formula