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Horizontal analysis and other methods

Managers look at the financial statement to see how well a company is doing, but the account balances alone do not tell managers enough. Horizontal and trend analyses are commonly used by managers to help assess the company's financial strengths and weaknesses. Explain what horizontal analysis and trend analysis are, how the numbers are used, and some of the advantages and disadvantages. Please also go through which of the methods you like best.

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Horizontal analysis is also called trend analysis; they mean the same thing. Horizontal analysis (or trend analysis) is a method of analyzing financial statements that shows how the amounts of corresponding financial statement items change over time. In other words, horizontal analysis considers the amounts for the same item, over several years, or several periods. Hence, this method is named horizontal analysis.

Typically, the earliest year or accounting period is used as the base period. The items on the statements for all the other periods are compared against the items on the base period. The following formulas are used when conducting horizontal analysis.

Dollar change = Dollar amount of the item in the comparison year - Dollar amount of the item in the base year

Percentage change = (Dollar change/Dollar amount of the item in the base year) * 100%

The percentage change is then used to determine trends. The numbers can be used, for example, to determine that cost increased (i.e. Dollar change) by, say, $10 million from one period to the next, and that the Percentage change was an increase of, say, 5%. This shows a trend in costs.

Horizontal analysis can be used to show dollar changes, percentage changes, or both. An example of how dollar amounts are used is in various national economic statistics, for example in the computation for GPD (Gross Domestic Product). Financial analysts might also use the dollar change to compare the company's costs before and after a new ...

Solution Summary

Different types of analysis methods are discussed in this solution. Examples are provided to explain when each type of analysis method is appropriate. This solution is answered in 970 words.

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