Horizontal Analysis - Online Tutor, Practice Problems & Exam Prep

Horizontal analysis evaluates percentage changes in account balances from one year to the next, aiding investors and creditors in financial statement analysis. The formula for percentage change is expressed as $(\mathrm{New}-\mathrm{Old})/\mathrm{Old}$. For example, if net sales increase from $58,081 to $65,455, the percentage change is approximately 12.7%. Understanding these changes in net sales, cost of goods sold, and gross profit is crucial for assessing a company's financial health.

Horizontal Analysis

So in this course, we not only learn how to create the financial statements, but also how to analyze them. One of the main ways that investors, creditors or even the company itself analyzes the financial statements is through a horizontal analysis. Let's check it out. So horizontal analysis, well, what it does, it's going to evaluate percentage changes in account balances from one year to the next. Alright, so we're going to go through different accounts; we could go through our cash account and see a percentage change between one year and the previous percent, okay? So all it is, is we're going to be computing the percentage change between the two years balances in the account, alright? So there's a two-step process here. The first thing we have to do is we have to compute the dollar amount of the change. Okay? The dollar amount of the change because that's the first part of the percentage change and then we have to take that dollar amount of change and we're going to divide it by the base period amount, okay?

So here we have the formula for percentage change. It's the current year amount minus the previous year amount, so that numerator right there, the numerator is the dollar change. Okay? This year's amount minus the previous year's amount, that's the dollar amount of the change and then we divide it by the previous year's amount just like in step two. current year amount - previous year amountprevious year amount*100.

So I have an easier way that I like to remember this; this is like the formal definition of a percentage change. This is the way I like to think of it. I just think new minus old divided by old, okay? We've got our new number minus the old number divided by the old number. We've got previous year amount in both cases. It's the same number. So new minus old over old new - oldold. That's the way I think of it. It's easier to remember than all those words. Cool?

So let me go through an example with you of how we compute percentage changes and then you guys can go ahead and try and do a horizontal analysis yourself. Alright? So we've got some company here that had net sales, cost of goods sold, and gross profit and it's asking us to compute the percentage change for each of them. So let me get out a calculator because this is not something I can do in my head and let's go ahead and go through our process. Remember, we've got new minus old and that's going to be this first step. New minus old and then the second step is divided by old. Okay? And that'll get us to the percentage change. Alright? So let's go ahead and do this. Let's start with our net sales and that was 65455 that was new, right? 2018 is the new, 2017 is the old. Alright? So we're trying to find the percentage change. How much did it change from 2017 to 2018? Well, let's find the dollar amount first. 65455 minus 58081, 7374, right? So there we go, we've got our dollar amount of the change, so there was an increase there, right? We also want to pay attention to the direction, did it go up or down? So that was an increase of 7374, and now let's go ahead and find our percentage change. So we got to divide it by which number are we going to divide by here? The 2017 number, right? The old number. So 58081, and that's going to be 0.1269, so remember we want to change it to a decimal, so you got to move the decimal place 2 places over and we're going to get a percentage change of 12.7%. I'm going to round it to just 1 decimal there, 12.7%.

Alright, so that's good information, right? Now an investor can say, wow, net sales have increased by 12.7%. That sounds pretty good, right? So let's go ahead and see our cost of goods sold. Let's see how cost of goods sold was affected as well. So we've got 54912 minus 45377, okay? So our cost of goods sold has also gone up. Our cost of goods sold went up by 9535, right? That was the dollar amount of the change and now let's go ahead and find the percentage change, right? How do we find the percentage change? We divide by the old, right? New minus old divided by old and I don't even clear my calculator, right? I leave that dollar amount change right there and I write it down and then I just divide 45377. So you just do it all in one step. So there we go. 9535 divided by 45377, it's going to give us a percentage change of 21.0%. So that was an increase as well. Is pretty good information too, right? Because now the investors say, hey, net sales went up by 12%. That's great. But now look at this. The cost of goods sold went up by 21%, right? That doesn't sound as good, right? They were able to increase their sales, but their costs went up even more than the sales went up, right? So at first glance, the net sales increase is like, hey, this is good, but it actually ended up that they made less in gross profit, right? Remember, gross profit is just net sales minus cost of goods sold, right? Gross profit is that first subtotal that we show on a multi-step income statement. So let's go ahead and calculate our gross profit, right? They didn't give it to us in the problem, but we can just figure it out right here by just subtracting the two numbers. So 65455 minus 54912. Well, that's going to be 10,543, right? So our gross profit in 2018 was $10,543, and how about in 2017? 58081 minus 45377. That was 12,704. So look at that, in 2017, we actually had more gross profit than in 2018, right? Even though we had less in sales, we were more efficient I guess, maybe we were getting better deals from our suppliers, maybe when we increase those sales, we couldn't get as good of a price for some reason, it was a rare thing we were trying to pick up and we had to pay more, whatever it is, our gross profit decreased, since 2017. So let's go ahead and finish up this problem and do our dollar amount of the change and our percentage change. So 10,543 minus 12,704. Well, that gives us a negative and I signify the negative by putting it in parentheses 2,161, right? So it's a negative 2,161, and you would have got the same number if you had subtracted down. The 7374 minus the 9535, whoops. 7374 minus 9535, well, it would have given you that same 2,161.

Alright, so let's get our last percentage change here. So how we calculate that? It's going to be the 2161, the negative 2161 divided by the old gross profit of 12,704, and it gives us a negative 17%, right? Negative 17.0%. I'm rounding to 1 decimal. So there we go. We see that our gross profit decreased by 17%. That's really good information for an investor, a creditor, and even the company itself, right? They're getting really good information by checking these percentages. Alright? So let's go ahead and pause here and now you guys try a horizontal analysis on an entire balance sheet, right? We can use horizontal analysis on income statements, balance sheets, on any kind of account here, alright? So let's go ahead and pause and you guys try this one.

Complete a horizontal analysis of the following balance sheet:

Alright. So let's go ahead and complete this horizontal analysis for a balance sheet. It's going to be pretty much like we did above with the income statement accounts, but now we're using balance sheet accounts. So I hope you guys did this in advance to get a little extra practice. If not, you might as well pause the video and do it now because I'm going to go kinda quickly here. I did all of the calculations ahead of time, just to save us time. There's going to be a bunch of calculations here. So remember, we've got to label our new and our old. Remember, our percentage change formulas, it's going to be the new minus the old, divided by the old. So the new year is 20x2, the old year is 20x1 and then the dollar amount of the change, well that's the new minus the old right here, right? New minus old and then we're going to divide that by the old to get the percentage change. Okay. So we're going to go account by account. Like I said, I did these numbers in advance, so let's do the first one. I'll talk in a little more detail. So first, we've got to do new minus old. So 262-1115, well, that gives us a dollar change of $7,697. So that tells us that cash increased by $7,697 from one year to the next, and then we take that, the $7,697 and we divide it by the old number, which was 18,514 to get our percentage change. $7,697 divided by 18,514, well, that's going to give us as a percentage 41.6%, right? So you'll get a decimal on your calculator, .416 and then you've got to move it over to 41.6. So I'm going to be rounding to just 1 decimal here on the percentages. So I'm going to start going down. We're going to go a little faster now. I'll still say what I'm doing. So we're going to do the new minus the old for accounts receivable, 15,912 minus 18,530. And notice, this time we get a negative number. 2,618, right? Because last year's balance was higher than this year's balance. So we get a negative number, but we divide that negative number still just the same way by the old number, 18,530. So negative 2,618 over 18,530, that gives us a negative 14.1%. Okay? So negative 14.1% that time. Let's keep going. This one's going to be negative as well, right? The inventory is a lower balance in the second year than the first year. So let's check it out. We're going to get a dollar amount of the change, new minus old of a negative 9,604, right? Negative 9,604 and our percentage change dividing that by the old number, 16,028, that's going to give us a negative 59.9%, right? So there we go. That tells us that the inventory has decreased almost 60% from one year to the previous year. Alright? Let's keep going here. PPE. So PPE 23,160-1,740 that gives us 6,120, and then we divide that by the old and we get 35.9%. Cool? Let's keep going. Total assets, so we can do this on the total basis as well, right? We're going to see how the total assets change year over year and we'll see that total assets has increased by 15.95 as a dollar amount and then we take that dollar change and divide it by the whole balance to get 2.3% change, right? So there we go, we've done all of our assets including total assets. Let's go ahead and do our liabilities and stockholders' equity accounts. So accounts payable, we can see it decreased, right? We had a lower balance in 20x2 than 20x1, so that's going to give us a negative number here and it's going to be negative 4,190 7. We divide that by the old balance of 13,759, we get a decrease of 30.5 percent, alright? So that's a decrease of 30.5. Let's keep going. Accrued expenses, this one stayed almost pretty stable here, but we saw that there was a decrease of $124, 6,117-6,241, and that is a 2% decrease, so -2%. Let's keep going. How about long term debt? So it went up by $5,000, right? $31,000 minus $25,000, that's a $5,000 increase in that liability. And when we take that $5,000 divided by 25,000, we get a 20% increase in long term debt. How about common stock? Look at this one. This is pretty common for this to happen actually where the common stock doesn't change. It's not like every year the company is going to be issuing new common stock, so this one is generally one that's might be pretty stable. So notice that it's the same year over year. There was no change in this account, so there's no percentage change in this account as well. Okay? 0 divided by 1,000 is 0. Cool. Same thing with APIC. APIC is another equity account related to that common stock. Additional paid in capital, we'll talk about that more in the equity section, but it's another one that generally stays pretty stable unless we're issuing new stock. So again, we had no change there. Right? No percentage change, no dollar change. Alright. Finally, oh, we got 2 more. So let's do retained earnings. So our retained earnings went up since last year. That means we had more income than we paid in dividends. Cool. So there we go. We had a $916 increase in our retained earnings which is 17.9% when we divide that. Let me get out of the way here just to make sure you've seen all the numbers. So yeah, retained earnings went up 17.9% and finally, let's do the last one here and notice that this is going to be the same as our change in total assets, right? Because these numbers are the same. Assets equal liabilities plus equity, so we're going to have the same changes here as well. So here we go. We've got 15.95 and a 2 point 3% change. Cool? So there is our horizontal analysis, for the balance sheet. You can see that these can be kind of timely, time-consuming. But if you start learning about excel, you can actually do all of this in a really quick fashion. Either way, this is how we do our horizontal analysis and then we can use this information to make better judgments with this financial statement. Cool? Alright. Let's go ahead and move on to our next video.

Here’s what students ask on this topic:

What is horizontal analysis in financial accounting?

Horizontal analysis in financial accounting is a method used to evaluate the percentage changes in account balances from one year to the next. This analysis helps investors, creditors, and the company itself to understand trends and make informed decisions. The formula for calculating the percentage change is:

$\frac{(\mathrm{New}-\mathrm{Old})}{\mathrm{Old}}$

For example, if net sales increase from $58,081 to $65,455, the percentage change is approximately 12.7%. This method can be applied to various financial statements, including income statements and balance sheets.

How do you calculate the percentage change in horizontal analysis?

To calculate the percentage change in horizontal analysis, follow these steps:

1. Compute the dollar amount of the change: $(\mathrm{New}-\mathrm{Old})$
2. Divide the dollar amount of the change by the base period amount (Old): $\frac{(\mathrm{New}-\mathrm{Old})}{\mathrm{Old}}$

For example, if net sales increase from $58,081 to $65,455, the dollar amount of the change is $7,374. Dividing this by the old amount ($58,081) gives a percentage change of approximately 12.7%.

Why is horizontal analysis important for investors and creditors?

Horizontal analysis is important for investors and creditors because it provides insights into the financial health and performance trends of a company over time. By evaluating percentage changes in key account balances, such as net sales, cost of goods sold, and gross profit, stakeholders can identify growth patterns, efficiency improvements, or potential financial issues. This information helps in making informed investment and lending decisions, assessing the company's ability to generate profits, and understanding its operational efficiency.

Can horizontal analysis be used on all financial statements?

Yes, horizontal analysis can be used on all financial statements, including income statements, balance sheets, and cash flow statements. This method allows for the evaluation of percentage changes in various account balances over different periods, providing a comprehensive view of a company's financial performance and trends. By applying horizontal analysis to different financial statements, stakeholders can gain a deeper understanding of the company's overall financial health and operational efficiency.

What are the steps to perform a horizontal analysis on a balance sheet?

To perform a horizontal analysis on a balance sheet, follow these steps:

1. Identify the account balances for the current and previous periods.
2. Compute the dollar amount of the change for each account: $(\mathrm{New}-\mathrm{Old})$
3. Calculate the percentage change by dividing the dollar amount of the change by the previous period's amount: $\frac{(\mathrm{New}-\mathrm{Old})}{\mathrm{Old}}$
4. Analyze the results to understand trends and financial health.

This process helps in identifying significant changes in assets, liabilities, and equity over time.