A1a. Horizontal analysis of financial statements involves the comparison of the financial ratio of a line item on an accounting document over different accounting periods. This will indicate behaviors in revenues, expenses, cash flow and any other line item of a financial statement of the course of time. Horizontal analysis will take multiple years, two or more, of financial data and give you the data change in a percent as well as a dollar amount. Analyzing this data can help give a company a competitive advantage through insight of how not only its own company is fairing in the market but what the competition is doing as well. These analyses are usually done monthly, quarterly or annually comparing the numbers from the same time frame from the past. Comparing these financial queues are great indicators on what type of financial situation is for the company and its market they are in and where the financial situation may be heading so the organization can adapt accordingly. Some of the problems a company can face when looking at the financial history and using the horizontal analysis is that the information and line items in the different chart of accounts (revenues, expenses, assets, and liabilities) may change or get put into a different account and cause variances between one period and another. (Accounting Tools) It can also be performed on ratios such as earnings per share (EPS), price earnings ratio, dividend payout, and other similar ratio.
Horizontal analysis can be performed in one of the following two different methods i.e. absolute comparison or percentage comparison. Absolute comparison is when comparing the currency amounts of some items over the period of time, for example comparing different accounting periods of the cash in hand. This method is helpful in identifying the items which are changing the most. Percentage comparison compares the percentage differences of certain items over a period of time. The absolute currency amounts are converted into the percentages for the purpose of this comparison. This method is useful when comparing performance of two companies of different scale and size in the same industry. When conducting a horizontal analysis is more effective if you review all of the financial statements at the same time, so that you can see the complete impact of operational results on a company's financial condition over the review period.
Competition Bikes, Inc. (CB) Comparative Income Statement Horizontal Analysis for years 6, 7, and 8 shows that CB increased their sales by 1/3rd from the year before in years 6 and 7, but went down by 15% the following year in 8. While looking into their cost of goods sold (COGS) also decrease by about the same margin as sales, 14.5%, their overall gross profit (GP) also decreased by slightly more as well, 16.3%. Due to increase in advertising, sales commissions, distribution and transportation, the overall sales expenses also decreased as well by 33%. With every year that you add increased sales, CB would expect to have higher selling expenses moving more products each year than the last and because you have moved more products which increase the work load and transportation costs of each unit. Because sales decreased during the last or 8th year, one would assume that the expenses would decrease as well, which they did by 14%, which also appears reasonable because each bike sold you accrue $30.00 a unit for transportation, plus you pay commission per piece, the distribution is on a per each basis that is why all three fluctuate the same percentage each year. So if you have an increase or decrease of one of these lines, all three of them will move at the same percentage up or down. While looking at the General and Admininstrative Expenses you will notice that an increase in Utilities would draw a red flag since it has increase up to 11.1% and the Other General and Administrative expenses has also