However, investors should combine horizontal analysis with vertical analysis and other techniques to get a true picture of a company’s financial health and trajectory. To perform a horizontal analysis, you must first gather financial information of a single entity across periods of time. Most horizontal analysis entail pulling quarterly or annual financial statements, though specific account balances can be pulled if you’re looking for a specific type of analysis.

• Trend percentages are similar to horizontal analysis except that comparisons are made to a selected base year or period.
• This is important as we continue our analysis of Coca-Cola Company throughout the chapter.
• For example, the total company-wide revenue last quarter might have been $75 million, while the total company-wide revenue this quarter might be $85 million.
• The analysis can help them with budgeting, deciding where to cut costs, how to increase revenues, and future capital investments opportunities.
• Despite these limitations, trend analysis remains a valuable tool in accounting for assessing a company’s financial health and making informed decisions.

Nike and PepsiCo both show the percent change in selected income statement line items for the past two years. Costco Wholesale Corporation presents selected income statement information for the past five years. The fact that these financial data are provided in the annual report confirms the importance of presenting trend information to shareholders. This means Banyan Goods saw an increase of $20,000 in net sales in the current year as compared to the prior year, which was a 20% increase. The same dollar change and percentage change calculations would be used for the income statement line items as well as the balance sheet line items.

Profitability ratios, such as gross profit margin and net profit margin, measure a company’s ability to generate profits from its operations. Liquidity ratios, like current ratio and quick ratio, assess a company’s ability to meet short-term obligations. Solvency ratios, such as debt-to-equity ratio and interest coverage ratio, gauge a company’s long-term stability and ability to repay its debts. Second, a variance analysis determines not only the dollar amount but the direction of change for a given general ledger account. Coverage ratios, like the cash flow-to-debt ratio and the interest coverage ratio, can reveal how well a company can service its debt through sufficient liquidity and whether that ability is increasing or decreasing. Horizontal analysis also makes it easier to compare growth rates and profitability among multiple companies in the same industry.

Noncurrent Assets and Noncurrent Liabilities

For example, earnings per share (EPS) may have been rising because the cost of goods sold (COGS) has been falling or because sales have been growing steadily. An alternate method of performing horizontal analysis calculations is to simply calculate the percentage change between two years as shown in the following example. Continued monitoring as time progresses will help us to get an even better understanding of the trends from this promotion. Knowing how promotions affect sales, wages and other expenses will help to be able to more successfully implement further programs to increase participation, and ultimately revenues.

In reviewing trend percentages, a financial statement user should pay close attention to the trends in related items, such as the cost of goods sold in relation to sales. Trend analysis that shows a constantly declining gross margin (profit) rate may be a signal that future net income will decrease. In conclusion, trend analysis is a valuable tool in accounting that allows businesses to gain insights into their financial performance over time.

What are the benefits and limitations of trend analysis in accounting?

This could be due to many factors, and Banyan Goods will need to examine this further to see why this change has occurred. These trend percentages indicate the
changes taking place in the organization and highlight the
direction of these changes. For instance, the percentage of sales
is increasing each year compared to the base year. Cost of goods
sold increased best fixed asset management software in 2021 at a lower rate than net sales in 20Y3 and 20Y5,
causing gross profit to increase at a higher rate than net sales. Operating expenses in 20Y4 increased due to the provision for
restructured operations, causing a significant decrease in income
before income taxes. Percentages provide clues to an analyst about
which items need further investigation or analysis.

Assess market position with performance reporting

In the current year, company XYZ reported a net income of $20 million and retained earnings of $52 million. Consequently, it has an increase of $10 million in its net income and $2 million in its retained earnings year over year. If Banyan Goods thinks this is too low, the company would try and find ways to reduce expenses and increase sales. This may mean the company is maintaining too high an inventory supply to meet a low demand from customers.

Calculating Trend Percentages

It provides valuable insights and helps in decision making by identifying patterns, predicting future outcomes, and highlighting potential risks and opportunities in various areas of an organization. Proper analysis does not stop with the
calculation of increases and decreases in amounts or percentages
over several years. Such changes generally indicate areas worthy of
further investigation and are merely clues that may lead to
significant findings.

Benefits and Limitations of Trend Analysis in Accounting

Understanding the purpose and importance of trend analysis in accounting sets the foundation for the subsequent section on the key steps in conducting a trend analysis. One of the key roles of trend analysis in accounting is its contribution to decision making. It provides crucial information that helps management and stakeholders make well-informed decisions. By examining trends in revenue, expenses, and other financial data, you can identify areas of improvement and determine the effectiveness of past decisions. For example, if you notice a consistent decline in sales over several quarters, you can investigate the underlying causes and take appropriate actions to reverse the trend.

This means net sales will be set at 100% and all other line items within the income statement will represent a percentage of net sales. The image below shows the comparative income statements and balance sheets for the past two years. Identifying and analyzing trends enables financial statement users to make critical decisions. In trend analysis, percentage changes are calculated for several years instead of between two years.

It involves examining financial statements to identify trends and relationships between financial data. Trend analysis in accounting is essential for making informed financial decisions. It allows you to understand the advantages of trend analysis in accounting and the role it plays in decision making. By analyzing trends in financial data, you can identify patterns, evaluate the company’s performance, and make accurate predictions about its future.