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Financial Accounting

Learn the toughest concepts covered in your Financial Accounting class with step-by-step video tutorials and practice problems.

Table of contents
14. Financial Statement Analysis

Horizontal Analysis


Horizontal Analysis

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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 gonna evaluate percentage changes, percentage changes in account balances from one year to the next. Alright. So we're gonna go through different accounts. We could go through our cash account and see a percentage change between one year and the previous year. We do it for inventory. We could do it for income statement accounts, equity accounts, every type of account. We can do a horizontal analysis. Okay. So all it is is we're gonna be computing the percentage change between the two years balances in the account. Right? 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. We're gonna 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, the dollar amount of the change right? This year's amount minus previous years 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. Alright. 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, right? We've got previous year amount in both cases, it's the same number. So New minus old over old. 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 uh 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 of 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 gonna 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. All right, 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 1st 65455 minus 58 oh 81 7374. Right? So there we go, we've got our dollar amount of the change. So there was an increase. Their 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 gotta divided by which number are we gonna divide by here? The 2017 number, right? The old number, So 58 oh 81 and that's gonna be 810.1 to see 69. So remember we want to change it to a decimal. So you gotta move the decimal place two places over and we're gonna get a percentage change of 12.7%. I'm gonna round it to just one 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 -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 gonna give us a percentage change of 21.0%. So that was an increase as well. This is pretty good information to write 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 the cost went up even more than the sales went up. Right? So at first glance, the net sales increases 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, uh, sub total 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 gonna be 10 543. Right? So our gross profit in 2018 was 5 10,043. And how about in 2017 58081 minus 45377. That was 12,007 04. 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 pay 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 2161. Right? So it's a negative 1 2061 and you would have got the same number if you had subtracted down the 7374 minus the 95357374 minus 9535. Well, it would have given you that same 2161. All right, So let's get our last percentage change here. So how we calculate that? It's gonna 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%. Um a rounding to one 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 get really good information by checking these percentages. Alright, so let's go ahead and pause here. And now you guys try a horizontal analysis 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:

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