This might aid the company in generating effective projects and planning for the future. It incorporates computations of key ratios or margins, such as the current ratio, interest coverage ratio, gross margin, and/or net profit margin, which can be highly insightful. To acquire relevant insights into how a firm is operating, it’s important to use several years of historical data for this analysis.

• All these are taken into account in relation to identifying your past financial performance and your prospects for the future.
• By examining year-to-year changes in key financial metrics, you can gain insights into a company’s growth, stability, and overall performance.
• By incorporating horizontal analysis into your financial analysis toolkit, you can gain valuable insights into your company’s performance and drive strategic growth.
• It means the changes are shown as a percentage of a base item in the statement and there are no representations for variance.
• This can create difficulties in detecting troublesome areas, making it hard to spot changes in trends.
• They involve calculating averages over a moving time window, which can help you spot underlying patterns while minimizing short-term fluctuations.

If you purchased several fixed assets during 2018, the increase is easily explained, but if you didn’t, this would need to be researched. Adding a third year to the analysis will be even more helpful, as you’ll be able to see if there is a definite trend. The horizontal analysis formula articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

Marketplace Financial Model Template

By looking at the numbers provided by a company, you should see whether there are any large differences between one year and the next. It is also possible to perform this analysis with time series data to make direct comparisons with other companies. 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. Ratios such as earnings per share, return on assets, and return on equity are similarly invaluable. These ratios make problems related to the growth and profitability of a company evident and clear.

The analysis can be performed on any of the four financial statements; however, we’ll focus on the balance sheet and income statement,‘ said Patty. Using this formula, the analyst can determine the percentage change between two years for any given financial statement line item. This calculation helps identify trends and fluctuations in financial performance, which is useful in making informed business decisions. Vertical analysis expresses each line item on a company’s financial statements as a percentage of a base figure, whereas horizontal analysis is more about measuring the percentage change over a specified period. With a solid understanding of horizontal analysis applied to income statements and balance sheets, you’ll be well-prepared to make informed financial assessments and decisions.

Selecting Financial Statements

A company that wants to budget properly, control costs, increase revenues, and make long-term expenditure decisions may want to use financial statement analysis to guide future operations. As long as the company understands the limitations of the information provided, financial statement analysis is a good tool to predict growth and company financial strength. From this, it is seen that, for instance, with vertical analysis, every item on an income statement is expressed as a percentage of the gross sales. On the other hand, every item on a balance sheet is expressed as a percentage of the total assets held by the firm. Looking at and comparing the financial performance of your business from period to period can help you spot positive trends, such as an increase in sales, as well as red flags that need to be addressed.