CFI is on a mission to enable anyone to be a great financial analyst and have a great career path. In order to help you advance your career, CFI has compiled many resources to assist you along the path. In conclusion, we’re able to compare the year-over-year (YoY) performance of our company from 2020 to 2021. The latter two tend to calculate inventory management costs go hand-in-hand because the most useful benchmark against which to compare recent performance is most often the preceding period. Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more.

Horizontal Analysis – Percentage Change

Vertical analysis, on the other hand, focuses on a specific period of time and studies the proportions of the total amount represented by the different variables for that period. External factors such as economic conditions, industry trends, and competitive dynamics can significantly influence a company’s financial performance. For example, a rise in revenue might be attributed to favorable market conditions rather than internal improvements.

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• This analysis is vital for investors, creditors, and other stakeholders in understanding whether a company can sustain its growth, meet its debt obligations, and generate shareholder value.
• Similarly, a company facing economic headwinds might show declining figures, but a closer look could reveal that it is outperforming its peers under the same conditions.
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For example, revenue is often split out by product line or company division, while expenses may be broken down into procurement costs, wages, rent, and interest paid on debt. With this type of report it is easier to spot trends in the financial information. For this business, the 2020 net income is 97% of the base year, and the 2021 net income is only 46% of the base year. In this second example, I will do a horizontal analysis of Company B’s current assets based on the annual balance sheets. The two examples below show how to do horizontal analysis using Google Sheets, but you can easily do the same in Excel.

Horizontal Analysis: Metrics, Methods, and Applications

Conversely, a decrease in operating expenses might suggest improved operational efficiency or cost-cutting measures that are bearing fruit. If we take historical data of the financial statements of a company for year 1 and year 2, then one can compare each item and how it has changed year-over-year. 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. 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.

This type of analysis makes it simple to compare financial statements across periods and industries, and between companies, because you can see relative proportions. Vertical analysis refers to the method of financial analysis where each line item is listed as a percentage of a base figure within the statement. This means line items on income statements are stated in percentages of gross sales instead of in exact amounts of money, such as dollars.

Steve Rogers has been a professional writer and editor for over 30 years, specializing in personal finance, investment, and the impact of political trends on financial markets and personal finances. Let's take an example of a company that has generated an income statement for the last two years. For this example, the analysis will be carried out on the data reported for 2021 and 2022.

Conversely, a decline in net income could be due to external economic downturns rather than operational inefficiencies. By contextualizing the numerical changes, analysts can derive more meaningful insights and avoid misleading conclusions. It reflects the company’s profitability after accounting for all expenses, taxes, and other deductions. By examining net income over multiple periods, stakeholders can assess the company’s ability to generate profit and sustain its operations. This metric is particularly valuable for investors who are interested in the long-term viability and profitability of the business.

It improves the review of a company’s consistency over time, as well as its growth compared to competitors. For example, let’s take the case of the income statement – if the gross profit in year 1 was US$40,000 and in year 2 the gross profit was US$44,000, the difference between the two is $4,000. The primary difference between vertical analysis and horizontal analysis is that vertical analysis is focused on the relationships between the numbers in a single reporting period, or one moment in time. Horizontal analysis looks at certain line items, ratios, or factors over several periods to determine the extent of changes and their trends.

With different bits of calculated information now embedded into the financial statements, it's time to analyze the results. The identification of trends and patterns is driven by asking specific, guided questions. For example, upper management may ask "how well did each geographical region manage COGS over the past four quarters?". This type of question guides itself to selecting certain horizontal analysis methods and specific trends or patterns to seek out. In addition to helping you determine your company’s current financial health, understanding income statements can help you predict future opportunities, decide on business strategy, and create meaningful team goals.

The percentage change is calculated by first dividing the dollar change between the comparison year and the base year by the line item value in the base year, then multiplying the quotient by 100. To perform a horizontal analysis, you must first gather financial information of a single entity across periods of time. Most horizontal analysis entail pulling quarterly or annual financial statements, though specific account balances can be pulled if you're looking for a specific type of analysis.