Learning Outcomes
- Perform a horizontal analysis of a company’s financial statements
Important information can result from looking at changes in the same financial statement over time, both in terms of dollar amounts and percentage differences. Comparative financial statements place two years (or more) of the same statement side by side. A horizontal analysis involves noting the increases and decreases both in the amount and in the percentage of each line item. The earlier year is typically used as the base year for calculating increases or decreases in amounts.
The presentation of the changes from year to year for each line item can be analyzed to see where positive progress is occurring over time, such as increases in revenue and profit and decreases in cost. Conversely, less favorable readings may be isolated using this approach and investigated further.
| Description | 2019 | 2018 | Change in dollars: 2018 to 2019 | Change in percent: 2018 to 2019 |
|---|---|---|---|---|
| Sales | $994,000 | $828,000 | 166,00 | 20.0% |
| Cost of merchandise sold | 414,000 | 393,000 | 21,000 | 5.3% |
| Gross Profit | Single Line$580,000 | Single Line$435,000 | 145,000 | 33.3% |
| Subcategory, Operating Expenses: | ||||
| Salaries expense | $77,000 | $64,000 | 13,000 | 20.3% |
| Rent expense | 63,000 | 52,000 | 11,000 | 21.2% |
| Insurance expense | 56,000 | 46,000 | 10,000 | 21.7% |
| Supplies expense | 49,000 | 41,000 | 8,000 | 19.5% |
| Advertising expense | 42,000 | 35,000 | 7,000 | 20.0% |
| Depreciation expense | 35,000 | 29,000 | 6,000 | 20.7% |
| Utilities expense | 28,000 | 23,000 | 5,000 | 21.7% |
| Total operating expense | Single Line348,000 | Single Line290,000 | 58,000 | 20.0% |
| Net income from operations | $232,000 | $145,000 | 87,000 | 60.0% | Subcategory, Other revenue and expenses: |
| Gain on sale of investments | $137,000 | $186,000 | (49,000) | -26.3% |
| Interest expense | (55,000) | (50,000) | 5,000 | 10.0% |
| Income before income tax | $314,000 | $281,000 | 33,000 | 11.7% |
| Income tax expense | 66,000 | 50,000 | 16,000 | 32.0% |
| Net income | Single Line$248,000 Double Line | Single Line$231,000 Double Line | 17,000 | 7.4% |
A horizontal analysis of Jonick’s 2018 and 2019 income statements appears above. The first two columns show income statement amounts for two consecutive years. The amount and percentage differences for each line are listed in the final two columns, respectively.
The presentation of the changes from year to year for each line item can be analyzed to see where positive progress is occurring over time, such as increases in revenue and profit and decreases in cost. Conversely, less favorable readings may be isolated using this approach and investigated further.
In this sample comparative income statement, sales increased 20.0% from one year to the next, yet gross profit and income from operations increased quite a bit more at 33.3% and 60.0%, respectively. However, the final net income amount increased by only 7.4%. Changes between the income from operations and net income lines can be reviewed to identify the reasons for the relatively lower increase in net income.
Likewise, the following is a horizontal analysis of a firm’s 2018 and 2019 balance sheets. Again, the amount and percentage differences for each line are listed in the final two columns and can be used to target areas of interest. For instance, the increase of $344,000 in total assets represents a 9.5% change in the positive direction. Total liabilities increased by 10.0%, or $116,000, from year to year. The change in total stockholders’ equity of $228,000 is a 9.3% increase. There seems to be a relatively consistent overall increase throughout the key totals on the balance sheet. Even though the percentage increase in the equipment account was 107%, indicating the amount doubled, the nominal (just the number) increase was just $43,000. This increase in relation to total assets of $3.95 million is only 1% and could easily be just one piece of equipment, or a vehicle.
All this is to say that as with all metrics and high-level analysis, a horizontal analysis like this is a way to identify areas of concern or even areas where things are going well, but further analysis is needed to determine what is really going on if anything.
| 2019 | 2018 | Amount | Percentage | |
|---|---|---|---|---|
| Assets | ||||
| Subcategory, Current assets: | ||||
| Cash | $373,000 | $331,000 | 42,000 | 12.7% |
| Marketable securities | 248,000 | 215,000 | 33,000 | 15.3% |
| Accounts receivable | 108,000 | 91,000 | 17,000 | 18.7% |
| Merchandise Inventory | 55,000 | 48,000 | 7,000 | 14.6% |
| Prepaid insurance | 127,000 | 115,000 | 12,000 | 10.4% |
| Total current assets | Single Line$911,000 | Single Line$800,000 | 111,000 | 13.9% |
| Subcategory, Long-term investments: | ||||
| Investment in equity securities | $1,946,000 | $1,822,000 | 124,000 | 6.8% |
| Subcategory, Property, plant and equipment: | ||||
| Equipment (net of accumulated depreciation) | $87,000 | $42,000 | 45,000 | 107.1% |
| Building (net of accumulated depreciation) | 645,000 | 581,000 | 64,000 | 11.0% |
| Land | 361,000 | 361,000 | ||
| Total property, plant and equipment | $1,093,000 | $984,000 | 109,000 | 11.1% |
| Total assets | Single Line$3,950,000Double Line | Single Line$3,606,000Double Line | 344,000 | 9.5% |
| Liabilities | ||||
| Subcategory, Current liabilities: | ||||
| Accounts payable | $120,000 | $109,000 | 11,000 | 10.1% |
| Salaries payable | 244,000 | 222,000 | 22,000 | 9.9% |
| Total current liabilities | Single Line$364,000 | Single Line$331,000 | 33,000 | 10.0% |
| Subcategory, Long-term liabilities | ||||
| Mortgage note payable | $83,000 | $83,000 | ||
| Bonds payable | 828,000 | 745,000 | 83,000 | 11.1% |
| Total long-term liabilities | Single Line$911,000 | Single Line$828,000 | 83,000 | 10.0% |
| Total liabilities | $1,275,000Double Line | $1,159,000Double Line | 116,000 | 10.0% |
| Stockholders’ Equity | ||||
| Preferred $1.50 stock, $20 par | $166,000 | $166,000 | ||
| Common stock, $10 par | 83,000 | 83,000 | ||
| Retained earnings | 2,426,000 | 2,198,000 | 228,000 | 10.4% |
| Total stockholders’ equity | Single Line$2,675,000 | Single Line$2,447,000 | 228,000 | 9.3% |
| Total liabilities and stockholders’ equity | $3,950,000Double Line | $3,606,000Double Line | 344,000 | 9.5% |
PRACTICE QUESTION
