What is Horizontal Analysis?
Horizontal analysis interprets the change in financial statements over two or more accounting periods based on the historical data. 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
Horizontal Analysis is used for evaluating trends year over year (YoY) or quarter over quarter (QoQ). If you are an investor and thinking about investing in a company, only a year-end balance sheet or income statement wouldn’t be enough for you to judge how a company is doing. You need to look at a couple of years at least to be sure. Better yet, if you can see many years of balance sheets and income statements and make a comparison among 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 each and every item. And on the basis of that, you can forecast the future and understand the trend.
You don’t need any special financial skill to ascertain the difference between the previous year’s data and last year’s data. All you need is diligence, attention to details, and a logical mind to decipher why the change happens.
In this GKSR example above, we are able to identify the YoY growth rate using Horizontal Analysis of Income Statement. It helps us identify potentials 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 are able to correctly identify the trends and also come up with relevant areas to target for further analysis.
Horizontal Analysis Formula
First, we need to take the previous year as the base year and last year as the comparison year. For example, let’s say we are comparing between 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
Horizontal Analysis Example
Let us assume that we are provided with the Income Statement data of company ABC. We need to perform horizontal analysis of the income statement of this company.
This is a basic example, where we have divided 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 = (change in value/original value)*100. It is used to calculate the percentage change in the original value. This change could be upward or downward. = 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. Here we have the YoY growth rates of Colgate’s Income statement from 2008 until 2015. We calculate the growth rate of each of the line items with respect to the previous year.
For example, to find the growth rate of Net Sales of 2015, the formula is (Net Sales 2015 – Net Sales 2014) / Net Sales 2014.
Here are the following observations from Colgate’s.
- In the last two years, Colgate has seen a dip in Net Sales figures. In 2015, Colgate saw a de-growth of -7.2% in 2015. Why?
- Cost of Sales, however, has decreased (positive from the company’s point of view). Why is this so?
- Net Income decreased in the last three years, with as much as 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.. The approach used here is fairly simple.
- Step 1 – Perform the horizontal analysis of income statement and balance sheet historical data.
- Step 2 – Based on the YoY or QoQ growth rates, you can make an assumption about future growth rates.
Let us now look at Colgate 10K 2013 report. We note that in the income statement, Colgate has not provided segmental information; 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 on the basis of this available data. We will use the sales growth approach across segments to derive the forecasts. Please see the below picture. 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. Total Net sales are the sum total of the Oral, Personal & Home Care, and Pet Nutrition Segment.
Horizontal Analysis Video
This article has been a guide to what is horizontal analysis. Here we discuss the formula of horizontal analysis on the income statement and balance sheet along with practical examples. You may go through the following articles for further readings on financial analysis