This analysis can uncover whether a company allocates an excessive portion of its revenue to certain costs, such as operating expenses or debt servicing, which can signal inefficiencies or financial risks. Secondly, in the second type of horizontal analysis, we are interested in knowing about the Travel Agency Accounting underlying trends in the line items of the income statement. For this, we compare the absolute change ($) and percentage change (%) in all the line items from one period to the other. One should ideally take three or more accounting periods/years to identify trends and how a company is performing from one year/accounting period to the next year/accounting period.

What is the Cash Ratio?

Here, for the sake of illustration, we have shown the absolute change (in US$) and percentage change (%) of all line items in the income statement between year 1 and year 2 only. 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 unearned revenue between the two is $4,000. Horizontal analysis, or “time series analysis”, is oriented around identifying trends and patterns in the revenue growth profile, profit margins, and/or cyclicality (or seasonality) over a predetermined period.

Vertical Analysis – Income Statement

Analyzing operating cash flow trends over time can reveal how effectively the company manages its day-to-day cash flow and whether it is self-sustaining. Both horizontal and vertical analysis have limitations but provide useful insights when analysing financial statements. However, it is difficult to establish a definitive trend based on only two or three periods of data. For this reason, it is imperative to exercise caution when formulating conclusions in the absence of additional information. According to a study conducted by Green and Clark in 2019, the reliability of trend identification is enhanced by 30% when financial data is analysed over a decade.

• Both horizontal and vertical analysis have limitations but provide useful insights when analysing financial statements.
• For useful trend analysis, you need to use more years (most investors use five), but this example gives you all the info you need to prepare a horizontal analysis for an unlimited number of years.
• The base year serves as the reference point for comparisons, while the current year represents the year under scrutiny.
• Nonetheless, continuous comparisons and the implementation of additional financial analysis techniques help to take care of this drawback.
• Analysts and investors will be able to identify factors that drive growth over a period of time.

Key Objectives and Purposes:

• This way, companies willfully maneuver and change their growth and profitability trends to their advantage.
• Analyzing these components over multiple years is instrumental in understanding a company’s financial stability and growth.
• A notable problem with the horizontal analysis is that the compilation of financial information may vary over time.
• By applying these advanced techniques, you can refine your horizontal analysis and provide more accurate insights and recommendations to stakeholders.
• By employing the same methodology on other accounts, it is possible to determine whether their percentage increases or decreases in comparison to the base year.
• Given below is a horizontal analysis in excel of a comparative income statement (i.e. year 1 – base, year 2, and year 3).

The evaluation and comparison through this analysis are in line with GAAP rules as well. The upwards shift in the net profit was mainly due to increased revenue for Meta. It reported a revenue figure of $ 85,965 million and $ 117,929 million for 2020 and 2021 respectively. You can then dig deeper to evaluate the positive or negative results calculated from the horizontal analysis.

This way, you can quickly see growth, as well as any red flags that require attention. Once we divide each balance sheet item by horizontal analysis formula the “Total Assets” of $500 million, we are left with the following table. The dollar change is found by taking the dollar amount in the base year and subtracting that from the year of analysis. Save time and effort with our easy-to-use templates, built by industry leaders. Explore our marketplace and find the perfect tool to streamline your processes today. By applying horizontal analysis in these practical scenarios, ManufacturingCo, Inc. enhances its financial decision-making processes and ensures adherence to regulatory standards.