Horizontal Analysis

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What is a 'Horizontal Analysis'

A horizontal analysis, or trend analysis, is a procedure in fundamental analysis in which an analyst compares ratios or line items in a company's financial statements over a certain period of time. The analyst uses his discretion when choosing a particular timeline; however, the decision is often based on the investing time horizon under consideration.

BREAKING DOWN 'Horizontal Analysis'

Horizontal analysis allows investors and analysts to determine how a company has grown over time. Additionally, analysts and investors could use horizontal analysis to compare a company's growth rates in relation to its competitors and industry. For example, when you hear someone saying that revenues increased by 10% this past quarter, that person is using horizontal analysis. Horizontal analysis can be used on any item in a company's financials from revenues to earnings per share (EPS) and is useful when comparing the performance of various companies.

Horizontal Analysis Example

Horizontal analysis looks at the trend of financial statements over multiple periods, using a specified base period. Horizontal analysis typically shows the changes from the base period in dollar and percentage. The percentage change is calculated by first dividing the dollar change between the comparison year and the base year by the item value in the base year, then multiplying the quotient by 100%.

For example, assume an investor wishes to invest in company XYZ. The investor may wish to determine how the company grew over the past year. Assume that in company XYZ's base year, it reported net income of $10 million and retained earnings of $50 million. In the current year, company XYZ reported net income of $20 million and retained earnings of $52 million. Consequently, it has in increase of $20 million in its net income and $2 million in its retained earnings year over year (YOY). Therefore, company ABC's net income grew by 100% YOY, while its retained earnings only grew by 4%.

Vertical Analysis vs. Horizontal Analysis

The difference between horizontal analysis and vertical analysis is that vertical analysis involves listing each item on a company's financial statement as a separate column. For example, in vertical analysis, cost of goods sold (COGS) and gross margin are typically listed as a percentage of sales. Assume company ABC reported sales of $50 million and had COGS of $25 million. Therefore, company ABC has a gross profit margin of $25 million. In vertical analysis, a column would be used to indicate the percentage of sales, which would show sales as 100%, COGS as 50% and gross profit margin of 50%.