Horizontal Analysis
Candlefocus EditorTo perform horizontal analysis, the financial statement user must select the base year, which is the earlier period of comparison. The selected line item for the base year is used as a benchmark for the following periods under analysis. By expressing each line item of the later periods as a percentage of the base year's line item, it's easy to measure the amount of growth (or decline) on a recurring basis. This method is especially beneficial to identify patterns of behaviour or even to notice abrupt changes. For example, if a company's sales are growing at a steady rate but there is a sudden decline in profits in the most recent period, then it could point to a problem that needs to be addressed.
It is important to note that using horizontal analysis can be manipulated to achieve desired outcomes. For example, if the base year is chosen to be a period with particularly poor performance, then the results of the analysis will be skewed such that the current performance looks relatively better. For these reasons, financial statement users must make sure to use an appropriate base year and to adjust their expectations accordingly when interpreting the results of horizontal analysis.
In summary, horizontal analysis is an effective tool to evaluate and compare a company’s financial performance over multiple periods. Although this method may be manipulated to produce desired outcomes, knowledgeable financial statement users can utilize its benefits to identify trends, changes in performance and growth.