How To Interpret Financial Statements

Using the comparative income statement above, you can see that your net income changed by $1,500 from 2017; a percentage increase of 5.3%, but what really stands out on the income statement is the 266% increase in depreciation expense. If you’d rather see both variances and percentages, you can add columns in order to display changes in both. While this format takes the most time to create, it also makes it easier to spot trends and better analyze business performance.

• For the greatest accuracy, you should ensure all the financial statements are prepared consistently according to the Generally Accepted Accounting Principles .
• Because this analysis tells these business owners where they stand in their financial environment.
• Comparability is the ability to review two or more different companies’ financials as a benchmarking exercise.
• For instance, if management establishes the revenue increase or decrease in the cost of goods sold is the reason for rising earnings per share, the horizontal analysis can confirm.
• This may include creditors, regulatory authorities, and industry observers like business journalists, among others.

First, run both a comparative income statement and a balance sheet for each of the periods you want to compare. You’ll need at least two to compare, but it will easier to find trends if there are three or more. As a result, some companies maneuver the growth and profitability trends reported in their financial horizontal analysis report using a combination of methods to break down business segments. Regardless, accounting changes and one-off events can be used to correct such an anomaly and enhance horizontal analysis accuracy.

Key Metrics in Horizontal Analysis

Step 2 – You can assume future growth rates based on the YoY or QoQ growth rates. For example, to find the growth rate of net sales for 2015, the formula is (Net Sales 2015 – Net Sales 2014) / Net Sales 2014. First, we need to take the previous year as the base year and last year as the comparison year. As we see, we can correctly identify the trends and develop relevant areas to target for further analysis. You do not need special financial skills to ascertain the difference between previous and last year’s data. However, it would be best if you had diligence, attention to detail, and a logical mind to decipher why the change happens. The cost of financing is taking a substantially bigger bite out of sales, with almost C0.05 out of every C1 of sales being spent on financing versus only C0.006 in 20X1.

A Vertical Analysis can be completed on both an Income Statement and a Balance Sheet. Unlike Horizontal Analysis, a Vertical Analysis is confined within one year ; so we only need one period of data to derived the percentages and completed the analysis. To calculate 2014, we DO NOT go back to the baseline to do the calculations; instead, 2013 becomes horizontal analysis the new baseline so that we can see percentage growth from year-to-year. For example, although interest expense from one year to the next may have increased 100 percent, this might not need further investigation; because the dollar amount of increase is only $1,000. By identifying a problem, businesses can then devise a strategy to cope with it.

Income Statement Ratios

The level of detail in your financial statements depends heavily on the accounting software you use. If you use entry-level software, you’ll most likely need to use spreadsheets like Excel or Google Sheets to conduct your horizontal analysis. For instance, instead of creating a balance sheet or income statement for one specific period of time, you would also create a comparative income statement or balance sheet that covers quarterly or annual activity for your business.

• The cost of financing is taking a substantially bigger bite out of sales, with almost C0.05 out of every C1 of sales being spent on financing versus only C0.006 in 20X1.
• Horizontal Analysis is performed by placing multiple years’ worth of data lined up next to each other and then graphing the data points to determine if there is a trend, and where it is going.
• Horizontal analysis involves looking at Financial Statements over time in order to spot trends and changes.
• By seeing the trend, which is a remarkable growth of over 100% from one year to the next, we can also see that the trend itself is not that remarkable of only 10% change from 2013 at 110% to 120% in 2014.
• Financial analysis of an income statement can reveal that the costs of goods sold are falling, or that sales have been improving, while return on equity is rising.

Here’s an example of an income statement from a fictional company for the year that ended on September 28, 2019. For starters, in 2016, Apple generated $0.39 for every $1 dollar in sales it made. However, Google’s other costs (such as sales, marketing, general & administrative, and R&D) are much higher, since Google’s EBITDA margin was 33.7%, compared to Apple’s 34.0%. For this example, the analysis will be carried out on the data reported for 2021 and 2022.

Key Parts of a Financial Statement

However, for the management and inventors to be able to make better-informed decisions an additional vertical analysis technique is necessary. In VERTICAL analysis is done by an analyst only for one accounting period and in which data is arranged in the column form in figures and percentage.

In addition, it helps us identify potential areas of growth and concerns. This ratio indicates how long the balance of stock on hand will last (i.e. the number of days supply in average inventory) and therefore highlights over/ under investments in inventory. Incorrect/ inconsistent valuation of inventory Obviously, if either the opening or closing balance of inventory has been valued incorrectly or inconsistently, the cost of sales will be distorted.

However the company is not utilizing the cash to meet the current liabilities which is not good for the business. 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 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. Once you have your company’s values for the variables of interest, you need to find those of similar companies in your industry for the selected time periods.

• If you’d rather see both variances and percentages, you can add columns in order to display changes in both.
• For example, an analysis of the last two quarters might look great, but when compared with the same period in the last year, it might look terrible.
• Both analyses involve comparing income statement accounts to each other in dollars and in percentages.
• Then, divide the change by the base year amount and multiply by 100 to get the percentage change.
• Further, operating income and net income have also witnessed higher growth due to a lower increase in SG&A expense and income tax respectively.
• Based on the above analysis we see that the sales has increased resulting in increase in retained earning and dividend payout.