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
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 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 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.

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.   

Problems with Horizontal Analysis

A common problem with horizontal analysis is that the aggregation of information in the financial statements
may have changed over time, due to ongoing changes in the chart of accounts, so that revenues, expenses,
assets, or liabilities may shift between different accounts and therefore appear to cause variances when
comparing account balances from one period to the next.

Horizontal analysis can be misused to report skewed findings. This can happen when the analyst modifies the
number of comparison periods used to make the results appear unusually good or bad. For example, the current
period's profits may appear excellent when only compared with those of the previous month, but are actually
quite poor when compared to the results for the same month in the preceding year. Consistent use of
comparison periods can mitigate this problem. Also, when an analysis is presented on a repetitive basis over
many reporting periods, any changes in the comparison periods should be disclosed, to make readers aware of
the difference.

Horizontal analysis can also be used to misrepresent results. It can be manipulated to show comparisons
across periods which would make the results appear stellar for the company. For instance, if the profits for this
month are only compared with those of last month, they may appear outstanding but that may not be the case
if compared with the same month the previous year. Using consistent comparison periods can address this
problem.

Is this increase because the company is now selling more of its products so there is a volume increase or is this increase
a result of changes in prices? Increase in prices. This could also be a change in the exchange rate which is favorable for
the company because we know that this company operates in multiple locations. But if there is an increase in price but
there is a decrease in volume, that would not be a great indicator. That's one example.

[00:06:14.170] - Speaker 1
Moving on to the cost of revenue now the cost of revenue has increased by 2.8 billion. Was this expected? Well. We did
expect an increase in the cost because we are seeing an increase in sales and usually revenue and cost of revenue or
cost of goods sold. They usually have proportional relationship because if you are selling ten units in one year and then
in the next year your units increase to 15 units you would expect an increase in your total sales dollars but you would
also expect an increase in your total cost dollars because of the increase of five units that you are selling more than last
year.