Horizontal analysis of comparative financial statements includes the
a. development of common size statements.
b. calculation of liquidity ratios.
c. calculation of dollar amount and percentage changes from financial statements over a period of time, as compared to a base year.
d. evaluation of financial statement data that expresses each item in a financial statement as a percentage of a base amount.
The correct answer and explanation is :
The correct answer is:
c. Calculation of dollar amount and percentage changes from financial statements over a period of time, as compared to a base year.
Explanation:
Horizontal analysis, also known as trend analysis, is a technique used in financial statement analysis to evaluate changes in financial data over a specific period. This method compares financial statements from different years to identify trends, growth patterns, or areas of concern.
The key feature of horizontal analysis is calculating the dollar amount and percentage changes in financial statement items, such as revenue, expenses, assets, liabilities, and net income. These changes are typically measured relative to a base year, which serves as a benchmark for comparison.
Formula for Horizontal Analysis:
- Dollar Change = Current Year Amount – Base Year Amount
- Percentage Change = (Dollar Change / Base Year Amount) × 100
For example, if a company’s revenue in 2023 was $500,000, and in 2022 it was $450,000, the horizontal analysis would show:
- Dollar change = $500,000 – $450,000 = $50,000
- Percentage change = ($50,000 / $450,000) × 100 = 11.1% increase
This method helps analysts, investors, and management to assess financial performance trends, detect potential risks, and make informed decisions.
The other options are incorrect because:
- (a) Common-size statements are part of vertical analysis.
- (b) Liquidity ratios measure a company’s ability to meet short-term obligations.
- (d) Expressing financial data as a percentage of a base amount is also part of vertical analysis.
By using horizontal analysis, businesses can gain valuable insights into their financial health and make strategic adjustments as needed.