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The Horizontal Method of Analyzing Financial Statements

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  • 0:03 Horizontal Method of Analysis
  • 0:35 What Is Horizontal Analysis?
  • 2:54 Balance Sheets
  • 3:33 Income Statements
  • 4:21 Retained Earnings Statements
  • 5:10 Lesson Summary
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Lesson Transcript
Instructor: Beth Loy

Dr. Loy has a Ph.D. in Resource Economics; master's degrees in economics, human resources, and safety; and has taught masters and doctorate level courses in statistics, research methods, economics, and management.

This lesson focuses on horizontal analysis, which is used to compare financial balances over time. Following this lesson, you'll be able to explain how to use the analysis for a balance sheet, income statement, and retained earnings statement.

Horizontal Method of Analysis

Have you ever been involved in organizing a fundraising campaign year after year? Well, if you've looked at what type of campaign raises the most money, you know about horizontal analysis. Say the one year you sold fruit, you increased your funds by 50% from the previous years when you did a car wash and a raffle. So, now you want to focus on fruit sales. This is an example of a decision you made based on the horizontal method of analyzing financial statements, known as horizontal analysis.

What Is Horizontal Analysis?

Horizontal analysis is done when an accountant compares different aspects of a business' finances over a certain period of time. It may be done over a month, season, quarter, year, or any other period of relevance. There are two methods for doing a horizontal analysis, which is sometimes referred to as a trend analysis. It can be done with dollars or percentages. Let's look at examples of each.

A dollar analysis looks at the amount of money left after a certain period. Say you're comparing quarters. You would look at the number of dollars left at the end of a quarter and compare that to other quarters.

For example, let's say we own an ice cream shop. We want to do a horizontal analysis on our slowest months, January through March, and we want to know if our off-season marketing effort is working. We will compare the first quarter of our fiscal year from 2014 to that quarter in 2015. A change in cash flow from $10,000 during the first quarter of 2014 to $15,000 during the same quarter of 2015 shows an increase of $5,000 (or $15,000 - $10,000). If nothing else has changed, we can surmise that our marketing effort is working.

A percentage analysis is where percentage differences in items are compared over certain time periods. Any dollar amounts are converted to percentages and used to make these comparisons.

Let's look again at the cash flows from our ice cream shop. We have a change in cash flow from $10,000 to $15,000. Our percentage analysis shows an increase of 50% (($15,000 - $10,000) / $10,000 = 0.5 or 50%). Again, this tells us that if nothing else changed during this time period, our marketing effort is working.

What else do these values tell you? Well, they help you figure out what is changing and why. Looking into these numbers further, you can see whether this is due to an increase in sales, reduction in costs, an anomaly, or even due to a change in marketing strategy. Most accountants report both numbers and percentages when doing a horizontal cost analysis. Typically, they're used to compare items from balance sheets, income statements, and retained earnings statements.

Balance Sheets

Balance sheets show us our total assets and total liabilities at a particular time. The difference would be the equity we have in our business. In our case it would be how much our ice cream shop is worth.

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