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What is Horizontal Analysis?
In business, horizontal analysis refers to a type of fundamental analysis in which a financial analyst uses certain financial data to assess a company’s performance over time. The analyst compares the same items or ratios for a particular company over a period of time in order to assess the company’s growth during that time. Horizontal analysis can also be performed on multiple companies in the same industry, to assess a company’s performance relative to its competitors.
The data used in horizontal analysis is found in a company’s financial statements, which include the balance sheet, income statement, and statement of cash flows. It can be line items, such as expense items, or it can be a ratio. A ratio is determined by comparing two or more items, for example, dividing expenses by net sales to determine the operating ratio.
Horizontal analysis can be performed on a quarterly or on an annual basis. Performance can be compared to the previous period or, in the case of quarterly analysis, to the same quarter in a previous year. If an analyst compares the same information from one quarter to the next, it is referred to as quarter-to-quarter, as in, ‘quarter-to-quarter sales increased 10 percent.’ If the comparison is to the same quarter in the prior year, it is referred to as quarter-over-quarter, as in, ‘quarter-over-quarter earnings were up 3 percent.’ In seasonal industries, such as retail, the quarter-over-quarter comparison is usually more valuable as it reflects the change compared to the same quarter a year ago.
The value of horizontal analysis lies in its usefulness in comparing the results of one company over time to determine whether its financial situation is improving. It is also useful for comparing the results of multiple companies in the same industry to determine which company has the best performance over time. It is most useful when comparing companies in the same industry, because metrics such as gross margin can vary widely from one industry to another.
In contrast to horizontal analysis, vertical analysis refers to the representation of assets, liabilities and equities as a percentage of the whole. These three major balance sheet categories are added up, and each one is expressed as the percent of the total it represents. Vertical analysis can be useful in comparing companies of different sizes, as it makes it easy to see which company has a greater percentage of liabilities as opposed to equity, or which company has more assets, relative to liabilities and equity.
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Discussion Comments
@Mammmood - I like graphs too, but I’d like to point out that a horizontal financial analysis is not as easy as a continually trending upward line graph.
That’s because while the revenue may increase, the gross profit margin may not. I’ve actually invested in stocks that reported better than average revenue, and the moment the quarterly report came out, the stock took a nosedive.
That’s because the profit margin was smaller than expected. Perhaps the cost of goods increased or there was increased pressure from competition, and so prices had to be slashed.
Whatever the reason, the health of a business involves more than its revenue. I agree that horizontal financial analysis is easy to parse; just look at all your numbers.
Well, that’s all the information I need to know how to do a horizontal analysis. I think this is the easiest kind of analysis to perform, actually, because it naturally lends itself to line graphs.
Also, I believe that we instinctively do this kind of analysis, even without formal training. In every endeavor, we are always asking the question, “Where have we been, and where are we going?”
Once a year in our small business we have the HR person and the president give us a presentation showing us that very thing. It’s always useful to see the numbers from quarter to quarter and year over year.
Importantly, we also use the analysis to do some kind of projection. We usually estimate something like 5% growth and are fairly accurate. As long as the graph lines keep trending up, and not down, I am happy.
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