Horizontal analysis is a technique for evaluating a series of financial statement data over a period of time
a. that has been arranged from the highest number to the lowest number.
b. that has been arranged from the lowest number to the highest number.
c. to determine which items are in error.
d. to determine the amount and/or percentage increase or decrease that has taken place.
The correct answer and explanation is :
The correct answer is:
d. to determine the amount and/or percentage increase or decrease that has taken place.
Explanation:
Horizontal analysis, also known as trend analysis, is a financial statement analysis technique that examines financial data over a period of time. It helps in identifying trends, patterns, and changes in financial performance by comparing specific items in the financial statements across multiple periods. This method is particularly useful for investors, analysts, and management to assess the company’s growth, profitability, and financial stability.
How Horizontal Analysis Works
The process of horizontal analysis involves:
- Selecting a base year – The financial data of a particular year is taken as a reference point.
- Comparing subsequent years – The financial figures of later years are compared against the base year.
- Calculating changes – The absolute and percentage changes are computed to understand the growth or decline in financial metrics.
The formula for percentage change is:
[
\text{Percentage Change} = \left( \frac{\text{Current Year Value} – \text{Base Year Value}}{\text{Base Year Value}} \right) \times 100
]
For example, if a company’s revenue was $500,000 in 2022 and increased to $600,000 in 2023, the horizontal analysis would show:
[
\frac{(600,000 – 500,000)}{500,000} \times 100 = 20\% \text{ increase}
]
Importance of Horizontal Analysis
- Identifies trends – Helps in spotting positive or negative financial trends.
- Detects financial issues – Unexpected declines may indicate problems.
- Aids decision-making – Management can make informed strategic decisions.
- Enhances investment analysis – Investors can analyze company performance over time.
Horizontal analysis is widely used in financial reporting to evaluate a company’s performance, compare it with industry benchmarks, and forecast future growth.