Horizontal analysis is the method of financial analysis, which shows the changes (ratio or difference) of the same item over time (e.g. a comparison of total assets at the end of the reporting period compared to the end of the previous year).
It is possible to compare to:
- the previous period (the most common), e.g. with the previous year
- the selected period, e.g. with a year three years back
- with an average of several previous periods, e.g. average for the last 3 years
It can be shown as
- difference of the same indicator in the financial statement over time (i.e. the absolute change):
- ratio of the same indicator to the value of the previous period
- ratio of the difference of the same indicator from the value of the previous year to the value of the previous period (i.e. the relative change):
calculation, if the values in the period t-1 are positive
simplified calculation, if the values in period t-1 is negative (the denominator multiplied by -1)
Note: This calculation is more complicated, but in practice, you can often well do just if the excel function "IF" on these two options.
(9, p. 14)
Purpose of horizontal analysis
- identifies the items with the highest absolute or relative change
- helps derive trend
- enables comparison of the percentage change in the output items compared to the percentage change in the input items → % changes in items of outputs (e.g. profit, sales) should generally be higher than in items of inputs (e.g. inventory, number of employees, wages), however, it also depends on the intentions of the company (9, p.16)
Disadvantages of horizontal analysis
- values for the previous period may not be available (new company, new product, different methodology for reporting the same item, etc.).
- ratio cannot be calculated if the value of the previous period is zero
- if the values for the previous period are negative, the formula for calculating the relative deviation must be adjusted
- it is necessary to understand the signs, (e.g. whether + 10% means an increase or decrease in costs)