Managerial Reporting: Horizontal Analysis

Introduction

Managerial reporting is a crucial component of any business's financial management strategy. It provides the necessary information for decision-making, planning, and control. One of the most effective methods used in managerial reporting is horizontal analysis. This article will delve into the concept of horizontal analysis, its importance, application, and how it can be leveraged to improve financial decision-making.

Understanding Horizontal Analysis

Horizontal analysis, also known as trend analysis, is a financial statement analysis technique that shows changes in the amounts of corresponding financial statement items over a period of time. It is a useful tool to evaluate trend situations. Horizontal analysis can be performed on any item in the financial statements, including revenues, expenses, assets, liabilities, and equity.

The primary purpose of horizontal analysis is to compare historical data, such as revenues or cost of goods sold, over a specified period. By doing so, it allows financial professionals to identify patterns, trends, and potential areas of concern or opportunity.

Horisontal analysis: Formula

Horizontal analysis (nominal) = Comparison period – Base period

Horizontal analysis(%) = (Comparison period – Base period) / Base period x 100

The Importance of Horizontal Analysis in Managerial Reporting

In managerial reporting, horizontal analysis plays a pivotal role for several reasons:

• Trend Identification: Horizontal analysis helps identify trends over time, which can be instrumental in strategic planning and forecasting.

• Performance Evaluation: It allows managers to evaluate the company's performance over a period, providing insights into how well the company is managing its revenues and expenses.

• Investor Relations: Horizontal analysis can be used to communicate with investors by showing the company's growth and profitability trends over time.

• Benchmarking: It can also be used for benchmarking purposes, comparing a company's performance with industry averages or competitors.

Application of Horizontal Analysis

Let's consider a fictional company, "TechNova Corp," to illustrate the application of horizontal analysis. TechNova Corp is a technology company that has been in operation for five years. The company's income statement for the past three years is as follows (in thousands):

• Year, Revenue, Cost of Goods Sold (COGS), Operating Expenses

• 2021 $500 $200 $150

• 2022 $550 $220 $170

• 2023 $600 $240 $200

To conduct a horizontal analysis, we calculate the percentage change from one year to the next. For example, the revenue growth from 2021 to 2022 is calculated as follows:

• ((550 - 500) / 500) * 100 = 10%

The same calculation can be done for COGS and operating expenses. The results can be tabulated as follows:

• Year, Revenue Growth, COGS Growth, Operating Expenses Growth

• 2021--2021 - - -

• 2022 10% 10% 13.33%

• 2023 9.09% 9.09% 17.65%

From the analysis, we can see that while TechNova Corp's revenue has been growing at a steady rate, its operating expenses have been growing at a faster rate. This could be a potential area of concern that the management needs to address.

Conclusion

Horizontal analysis is a powerful tool in managerial reporting. It provides a clear picture of a company's financial health over time, allowing managers to make informed decisions. However, it's important to note that horizontal analysis should not be used in isolation. It should be complemented with other financial analysis techniques such as vertical analysis and ratio analysis for a comprehensive view of the company's financial performance.