Financial Analysis

and
Reporting
Topic: Horizontal Analysis

Group 1:
Catherine A. Chin
Cristine O. Gabuya
Juneven Lawan
Novie John Dable
Maricel E. Ducay
Blaire Glyka Ilusorio
Ritchel Dela Rama
Mary Rose Villaester
Alfedie Barco

Instructor: Mr. Julius Oflas, LPT, MBA

 The financial analyst's experience, judgment, and temperament affect the evaluation of
financial statements (Mejorada, 2000). A basic set of financial statements includes a balance
sheet at a specific date and an income statement for the accounting period ended on that date.
Some sets of financial statements may include a balance sheet and income statement for both the
previous and current accounting periods. When prior and current period statements are provided,
changes occurring between the two consecutive years or periods can be seen. However, these
changes might not be as obvious as you would expect. It is not easy to mentally compare the
differences between sets of figures, and it is extremely useful to have additional information for
analysis. Thus, the analyst should be competent enough to appropriately use the common tools
and techniques used in the analyses of financial statement. One of these tools and techniques is
the Horizontal Analysis.

Horizontal analysis is a financial statement analysis technique that shows changes in the
amounts of corresponding financial statement items over a period of time. It is a useful tool to
evaluate the trend situations. Thus, analysts use such an approach to analyze historical trends.
Trends or changes are measured by comparing the current year’s values against those of the base
year. With horizontal analysis, we use a line-by-line comparison (compare each line item from
base to the chosen accounting period) to the totals. That’s exactly why it’s called horizontal
analysis – we compare the data from each period side by side to calculate the results. The goal is
to determine any increase or decline in specific values.

Horizontal Analysis in Reporting Standards

By comparing historical financial information the company can easily determine their
growth and position compared to their competitors. For the greatest accuracy, the company
should ensure all the financial statements are prepared consistently according to the Generally
Accepted Accounting Principles (GAAP).

As outlined in the Generally Accepted Accounting Principles (GAAP), the rules for the
preparation of financial statements require financial statements to be consistent and comparable
to compare and evaluate companies and their financial performance properly. Consistency
constraint here means that the same accounting methods and principles must be used each year
since they remain constant over the years.

On the other hand, comparability constraint dictates that a company’s financial statements
and other documentation be such that they can be evaluated against other similar companies
within the same industry. Horizontal analysis is used to improve and enhance these constraints
during financial reporting.

Therefore, analysts and investors can identify factors that drive a company’s financial
growth over a period of time. They are also in a position to determine growth patterns and trends,
such as seasonality. The method also enables the analysis of relative changes in different product
lines and projections into the future.

Purpose of Horizontal Analysis

To conduct a horizontal analysis, each financial statement line item will be compared to one
or more of the same items in the preceding year, or any other appropriate time period.

For example, when conducting a horizontal analysis of a company’s balance sheet, the
balances for each asset, liability, and equity item for each year would be compared with the
preceding year’s amounts. The changes in the amounts of the items from one year to the next can
then be compared and analyzed. The purpose of horizontal analysis is to provide insight
regarding the performance and financial position of an entity. A business can identify the areas in
which it is performing well or has improved and areas in which performance or position has
declined. Business owners and financial managers can then use this information to develop
strategies to address any issues that are identified.

How to perform Horizontal Analysis?

The horizontal analysis of financial statements is a relatively straightforward process. As can
be seen above, the calculations involved are simple. The focus should be on analysis and
interpretation, including which variables and periods you choose.

1. Select Time Periods

First, decide which periods you will be comparing, carefully choosing comparable periods. For
example, if your industry is seasonal, comparing consecutive quarters would provide misleading
results. It would make more sense to compare the values for a specific quarter to the same
quarter from past years. If you happen to choose a particularly bad time period for your base
values, the values for your comparison period may look much better than they are.
 2. Gather Data
The next step is to identify the data you need. Depending on the metrics you want to focus on,
you will need different financial statements, like balance sheets, income statements, or cash-flow
statements.

Once you have your company’s values for the variables of interest, you need to find those of
similar companies in your industry for the selected time periods. 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. Remember to choose
companies with similar characteristics for useful comparisons.

3. Calculate the Amount Change and Percentage Change

It’s possible to do horizontal analysis by computing amount change instead of the percentage
change. In calculating the amount change use the formula:

Amount Change = Current Year – Base Year

However, expressing the change as a percentage tends to be more useful, as it allows you to
easily compare to other companies and study proportional change. For each variable, calculate
the percentage change using the formula:

Percentage change = (( Current Year – Base Year) / Base Year) * 100)

4. Analyze & Compare Results

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.

Horizontal Analysis Formula and Examples

 We can do horizontal analysis using only two periods for the comparison, but it’s highly
recommended we use more to avoid drawing and acting on less accurate conclusions. The
earliest period is usually used as the base period and the items on the statements for all later
periods are compared with items on the statements of the base period. Horizontal analysis can be
performed by two means of calculation: Amount Change and Percentage Change.

We can derive the formula for horizontal analysis (amount change) by deducting the amount
in the base year from the amount in the current year. Mathematically, we represent it as,

Amount Change = Current Year – Previous Year

The formula for horizontal analysis (% change) can be derived by dividing the difference
between the amount in the current year and the base year’s amount in the base year.
Mathematically, we represent it as,

Percentage change = (( Current Year – Base Year) / Base Year) × 100)

Completing comparative horizontal analysis of any item, subtotal, or total appearing in a

financial statement is not the difficult part of a comparative analysis. The difficult part is
understanding what the analysis is telling you.
Illustration 1. Shows balance sheet information for three successive years, and the identity of
each line item, subtotals, and totals for all assets, liabilities, and stockholders’ equity is shown. In
addition, two extra columns are added for comparative analysis, one to show the peso value
change and the other to express the percentage of change for each line item reported.
Illustration 2. Shows income statement information for three successive years.

Illustration 3. Shows statement of retained earnings information for two successive years.
Advantages of Horizontal Analysis
Horizontal analysis is a powerful tool for financial statement analysis that can provide users
with valuable insight into the financial performance of a company.
The advantages of horizontal analysis are:
• Identifying Trends and Patterns:
Horizontal analysis is an effective tool for analyzing the trend in the financial performance of the
company over a period of time. It allows analysts to see how different financial items have
evolved over a period of time, whether in terms of revenue, expenses, profits or other items
related to the financial statements.

• Comparisons Made Easy:

Horizontal analysis is a great way to compare a company’s financial performance with the
averages for its industry or with its previous performance. This enables analysts to assess how
the company is performing relative to its peers and how it is trending from one period to the
next.

• Helps Analyze Performance of Different Items:

Horizontal analysis helps to break down individual financial statement items. It allows analysts
to evaluate the performance of each item by seeing how it has grown or declined over the prior
periods. Horizontal analysis is an important tool that can provide useful insights into a
company's financial performance. Analysts should use horizontal analysis along with other tools
of financial statement analysis to gain a better understanding of the results.

Disadvantages of Horizontal Analysis

Regardless of how useful trend analysis may be, it is regularly criticized. One reason is that
analysts can choose a base year where the company’s performance was poor and base their
analysis on it. In this way, the current accounting period (or any other accounting period) can be
made to appear better.
 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.

Another notable problem with the horizontal analysis is that the compilation of financial
information may vary over time. It means that elements of financial statements, such as
liabilities, assets, or expenses, may change between different accounting periods, leading to
variation when account balances for each accounting period are sequentially compared.

As a result, some companies maneuver the growth and profitability trends reported in their
financial horizontal analysis report using a combination of methods to break down business
segments. Regardless, accounting changes and one-off events can be used to correct such an
anomaly and enhance horizontal analysis accuracy.

A business will look at one period (usually a year) and compare it to another period. For
example, a business may compare sales from their current year to sales from the prior year. The
trending of items on these financial statements can give a business valuable information on
overall performance and specific areas for improvement. Financial analysts can use horizontal
analysis to identify relative changes in financial statements over different periods of time. By
comparing financial statements of multiple years, companies can detect patterns in performance
or problems that may otherwise be overlooked. It is a valuable tool used to assess long term
financial performance of a company. It provide insight into a company’s performance and
financial position, making it easier for business owners and financial managers to understand the
direction their business is taking. The results of the analysis can help business owners and
financial managers identify any issues that need to be addressed, develop strategies to improve
performance, and make smarter decisions.
To conclude, it is always worth performing horizontal analysis, but it should never be relied
upon too heavily. Other factors should also be considered, and only then should a decision be
made.