Definition: Horizontal analysis, sometimes called trend analysis, is the process of comparing line items in comparative financial statements or financial ratios across a number of years in an effort to track the history and progress of a company’s performance. In other words, it’s a way for analysts to compare accounts or performance metrics over time to see if the company is improving or declining.
What Does Horizontal Analysis Mean?
This formula for evaluation is typically done by either investors and internal company management since both need to understand how well a company is doing in order to make decisions. Investors have to make the decision whether or not they want to invest or sell their current investment; while management needs to know what moves to make in order to improve the future performance of the company.
Since, any line item in a financial statement or financial ratio can be compared across a period of time, it makes the horizontal analysis extremely useful for anyone trying to track a company’s performance over time.
Example
An investor can see if a business is expanding and becoming more valuable or becoming less efficient and less valuable. For example, an investor can use the horizontal analysis of the balance sheet to track the earnings per share ratio on a company he is thinking about investing in. If the ratio continues to grow year over year, the investor’s analysis would show a positive trend and he would probably choose to invest in the company granted other metrics are equally as positive.
A manager, on the other hand, is concerned with the day-to-day operations of the company, so he uses this evaluation technique to pinpoint areas for improvement. For instance, a manager might compare cost of goods sold and profit margin over a two or three-year span to see how efficient the company is becoming. This comparison of income statements will give the manager not only a benchmark for future performance; it will also help him understand what needs to be changed in the future.
Alhtough this comparison is useful on its own, investors and management typically use both horizontal and vertical analysis technuques before making any decisions.
