Finance Topics
IN THIS LESSON
It’s essential to compare the financial statements of your company...
…over two or more accounting periods.
Horizontal Analysis is an analytical method used to compare financial statements—primarily the balance sheet and income statement—based on historical data, in order to uncover the financial performance of your company over a specified period of time. To conduct horizontal analysis, i.e., evaluate underlying trends, it’s essential to compare the financial statements of your company over two or more accounting periods.
Carrying out horizontal analysis of the income statement and balance sheet helps investors and creditors to determine the current financial position of your company. By looking at past performance, it can help you assess growth rates, spot trends (by comparing changes from period to period), generate forecasts, or project the insights gained into the future. Horizontal analysis can help evaluate your company’s financial standing or position over its competitors.
Video Transcript:
Now let's take a look at how to perform a horizontal analysis of your balance sheet. Balance sheets show the worth of the company by comparing assets to liabilities and owner's equity. Let's compare different items on the balance sheet from this year and last year. New minus old divided by old equals the percent of change. Let's start with assets.
How has our cash on hand changed from year one to year two? Using our formula, you take $60,000 in cash for year two and subtract your $40,000 in cash from year one, which gives you a difference of $20,000. Divide the $20,000 difference by your year one cash amount of $40,000, and you find that you had a 50% increase in cash. Let's look at another asset, inventory. Your inventory has increased to a $100,000 in year two from $60,000 in year one, which means you have invested in equipment or have lots of raw materials or products on hand that aren't selling.
Although your percentages may not always total a 100%, the percentage change of assets should equal that of the liabilities and equity for the equation to balance. In our example, the percentage change is 66.7%. This rate may tell you that your inventory has increased substantially. Therefore, use it to decide if you should purchase more materials or wait until your percentage increase is more in line with general industry norms. Notice how your current and long term liabilities have increased a 100% from year to year too.
This means you may have spent a lot of money on inventory. Compare these rates to what's normal for your industry and adjust accordingly.