If you want to understand how a company’s financial performance has changed over time, you need to use horizontal analysis. Horizontal analysis, also known as trend analysis, is a technique that compares financial statement data across multiple periods. It helps you identify trends, patterns, and shifts in a company’s financial situation.

Horizontal analysis can be applied to any financial statement, such as the income statement, balance sheet, or cash flow statement. You can use either absolute or percentage comparisons to measure the changes in each line item. For example, you can compare the revenue of a company in the current year with the revenue in the previous year, or you can calculate the percentage change in revenue from one year to another.

Horizontal analysis can reveal a lot of useful information about a company’s performance, such as:

• Growth rate: You can see how fast a company’s revenue, earnings, or assets are growing or declining over time. This can indicate the company’s competitive position, market share, and profitability potential.
• Profitability: You can analyze how a company’s profit margins, return on equity, or earnings per share have changed over time. This can show you how efficient and effective the company is at generating profits from its operations and investments.
• Liquidity: You can assess how a company’s current assets, current liabilities, or cash flows have changed over time. This can tell you how well the company can meet its short-term obligations and fund its daily operations.
• Solvency: You can evaluate how a company’s long-term debt, equity, or interest coverage ratio have changed over time. This can indicate how well the company can service its long-term debt and maintain its financial stability.

To illustrate how horizontal analysis works, let’s look at an example of a company’s income statement for the last three years:

Income Statement	2022	2021	2020
Revenue	500	450	400
COGS	300	270	240
Gross Profit	200	180	160
Operating Expenses	100	90	80
Operating Income	100	90	80
Interest Expense	20	18	16
Income Before Tax	80	72	64
Income Tax	24	21.6	19.2
Net Income	56	50.4	44.8

We can use horizontal analysis to calculate the absolute and percentage changes in each line item from 2020 to 2022:

Income Statement	2022	2021	2020	Change (2020-2022)	% Change (2020-2022)
Revenue	500	450	400	100	25%
COGS	300	270	240	60	25%
Gross Profit	200	180	160	40	25%
Operating Expenses	100	90	80	20	25%
Operating Income	100	90	80	20	25%
Interest Expense	20	18	16	4	25%
Income Before Tax	80	72	64	16	25%
Income Tax	24	21.6	19.2	4.8	25%
Net Income	56	50.4	44.8	11.2	25%

From the horizontal analysis, we can see that the company’s revenue, COGS, gross profit, operating income, interest expense, income before tax, income tax, and net income have all increased by 25% from 2020 to 2022. This means that the company has maintained a consistent growth rate and profitability ratio over the last three years. However, it also means that the company has not improved its efficiency or effectiveness, as its operating expenses and interest expense have also increased by the same proportion as its revenue and gross profit. Therefore, the company may need to look for ways to reduce its costs and leverage its assets more optimally.

Horizontal analysis is a powerful tool for financial analysis, as it can help you spot trends and patterns in a company’s financial performance over time. By comparing financial statement data across multiple periods, you can gain insights into a company’s growth, profitability, liquidity, and solvency. You can also use horizontal analysis to benchmark a company against its competitors or industry averages, and to project its future performance based on historical data. Horizontal analysis can help you make better financial decisions and evaluate a company’s strengths and weaknesses.