FA 51 – Vertical Analysis
How does vertical analysis work?
You can use vertical analysis on an income statement, balance sheet, or cash flow statement to comprehend how each line item fits into the overall picture, recognize significant trends over time, compare several businesses of various sizes, or compare a company’s financial statements to industry averages.
You can perform these financial analytics and comparisons more effectively and more easily by using percentages. You can proportionally compare a company’s relative account balances to those of another company or the industry average because the vertical analysis method uses percentages to represent each line item, regardless of whether the other company’s or industry average’s total sales are higher or lower than the company you are analyzing.
If a financial statement does not already show each line item as a percentage when you want to perform a vertical analysis, you can find the percentage of each line item by dividing the line item amount by the base figure and multiplying the resulting dividend by 100. .
What is vertical analysis?
Financial statements that list each line item as a percentage of the statement’s base figure are analyzed vertically. The base figure is always displayed on the first line of the statement at 100%, and each item that follows it is represented by a percentage of the total. An income statement, for instance, shows each line as a percentage of gross sales, while a cash flow statement shows each cash inflow or outflow as a percentage of total cash flows.
Vertical analysis vs horizontal analysis
The main distinction between horizontal and vertical analysis is that the former uses percentages to show each line item’s percent change from quarter to quarter (QoQ) or year to year (YoY) to year. The formula for a horizontal analysis, in contrast to the formula for a vertical analysis, looks at the percent change in an item’s value from one period to another. The formulas for vertical analysis and horizontal analysis are contrasted below:
However, it’s crucial to keep in mind that you can still use vertical analysis to contrast the percentages of a line item from one quarter or year to the next. The primary distinction is that in a vertical analysis, the percentages do not correspond to the percentage of change.
Vertical analysis examples
Examples of various scenarios where vertical analysis can be applied to an income statement are provided below:
Example of vertical analysis on an income statement with expenses
Understanding how a company’s costs are affecting its overall net profit is one of the most frequent uses of vertical analysis. The graph below displays a company’s income statements for two years along with expenses, along with total dollar amounts and percentages:
In this illustration, you can see right away that even though the company’s overall sales increased in year two, its gross and net profit percentage decreased. The vertical analysis method reveals that costs did not increase proportionately to the increase in sales, contrary to what you might expect to happen as the total amount of sales increases.
Only 25% of the company’s total sales represented the cost of goods sold in year one; however, that proportion rose to 30% in year two. In order to increase gross and net profits in year three, the business must lower its cost of goods sold while attempting to boost or maintain total sales.
Example of vertical analysis on an income statement with revenue
Understanding how much each product or service a business offers contributes to its overall sales is another way to use vertical analysis. The revenue generated by each of a company’s products or services is represented in the following chart along with total dollar amounts and percentages from the income statement:
You can quickly see in this example that while the company’s total sales increased in year two, its cost of goods sold also increased by 5%, resulting in a 5% loss in profit between years two and one. The lower part of the graph displays the contribution of each product to the company’s annual sales.
Using the vertical analysis method, you can see that the percentage of the company’s total sales that came from dresses and children’s clothing stayed the same between years one and two, while the percentage of the company’s total sales that came from jeans, purses, and shoes shrank between years one and two. The percentage of the company’s total sales that came from t-shirts, however, increased by 10% between years one and two. According to this data, the company’s sales of jeans, handbags, and shoes didn’t perform as well in year two as they did in year one.
You can determine the best ways for the company to boost its overall sales and profit margins by combining this information with other details about it, such as where they concentrated their marketing efforts each year.
FAQ
What is a vertical analysis?
- Vertical Analysis formula = Individual Item / Base Amount *100.
- Income Statement Item = Income Statement Total Sales * 100 for the vertical analysis formula.
What is vertical analysis and horizontal analysis?
Financial statement analysis technique known as “vertical analysis” lists each line item as a percentage of a statement’s base figure.
