Vertical analysis helps in understanding the structure and composition of financial statements, while horizontal analysis helps in identifying trends and growth patterns over time. With vertical analysis, one can compare and contrast the financial statements of one company with another, or across various companies. When each income statement or balance sheet item is given as a percentage of total sales and total assets respectively, one can view and compare the relative proportion of each item across companies. This helps in assessing relative profitability, efficiency and competitiveness among other factors over time.

• They can understand whether the strategies and policies that they implement regarding sales, revenue, marketing, etc are really contributing to the betterment of business performance.
• Vertical Analysis using the Balance Sheet helps in understanding the proportion of each asset, liability, and equity item in companies.
• By focusing on the relative size of each line item, stakeholders can quickly identify areas of strength and concern within the financial statements.
• This analytical tool allows you to compare different periods or companies and identify trends or areas for improvement.

Formula

Vertical analysis formulas are used by businesses to compare the proportions of different line items to industry averages or those of other companies in the same industry. By doing this, businesses can identify areas where they are over or underperforming and adjust their strategy accordingly. This provides a basis for benchmarking against industry standards, which is how vertical analysis works. According to KPMG, companies that benchmark using vertical analysis outperform their peers by 12% in profitability. Vertical analysis is a useful tool for evaluating financial statements, with over 90% of Fortune 500 companies using it in their financial reporting process according to a survey by PwC. The widespread adoption of vertical analysis indicates its effectiveness in providing insights into the financial health and performance of companies.

The key components of vertical analysis are base figure, percentage calculation, common size financial statements, trend analysis, comparative analysis, structural composition, and key ratios. Such a breakdown helps decision-makers assess liquidity, debt levels, and overall financial stability, guiding strategic decisions regarding capital structure and risk management. The common size or vertical analysis of the income statement is the statement where each line item is expressed as a percentage of sales.

This method allows for easy comparison across different periods or companies. Vertical Analysis using Income Statements can highlight trends in revenue, expenses, and profitability. Another form of financial statement analysis used in ratio analysis is horizontal analysis or trend analysis. The importance of vertical analysis in financial reporting cannot be overstated.

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This vertical analysis provides insights into the company’s financial structure and the proportion of financing coming from debt versus equity. Vertical analysis provides a clear, proportional view of a company’s financial health. By focusing on the relative size of each line item, stakeholders can quickly identify areas of strength and concern within the financial statements. This method simplifies complex financial data, making it accessible and actionable for informed decision-making. Vertical analysis also enhances the transparency of financial statements, making it easier to interpret complex data.

They use it to express financial statement line items as percentages of a base figure, providing insight into financial relationships. This method is essential for evaluating a company’s financial health and operational efficiency. Vertical analysis is a kind of financial statement analysis wherein each item in the financial statement is shown in the percentage of the base figure. It is one of the popular methods of financial statements as it is simple and also called a common size analysis.

Investors and creditors also rely on vertical analysis to assess a company’s financial health and stability. By comparing vertical analysis results with industry benchmarks, stakeholders can gain insights into a company’s competitive position and operational efficiency. Vertical Analysis using Income Statements helps in understanding the proportion of each expense and revenue item. For instance, suppose the total revenue is Rs.10 crore and the cost of goods sold (COGS) is Rs.4 crore, then the COGS would be 40% of total revenue. Vertical Analysis using Income Statements is a method where each line item is represented as a percentage of a base figure, typically total revenue. Vertical Analysis using Income Statements provides insight into the operational efficiency of a company.

Vertical Analysis for Balance Sheets

Comparing each number becomes easier when compared as a percentage of sales/revenue. While such an analysis is helpful for the analysts to compare the company’s performance over the years or two Companies in the same sector and line of business, it has its limitations. Thus, the analysis should consider the limitations of the vertical analysis of the income statement while comparing and inferring the results. Likewise, all the items in the balance sheet are stated as a percentage of the total assets. The opposite of the vertical analysis of financial statements is the Horizontal analysis always looks at the amount from the financial statement over the horizon of many years.

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The management can identify areas of improvement or strength that are extremely useful for future planning. Thus, it provides insight into the business’s performance and financial structure. This concept of expressing the line item or a particular category of the income statement in terms of or as a percentage of the base amount is a very useful financial analysis technique. This base amount, which in this case, is the sales or revenue, provides a very useful platform for comparison of each item on a year on year or quarterly analysis.

• In summary, applying vertical analysis to the income statement provides a clear, proportional view of financial performance.
• Vertical analysis enables trend analysis as it converts financial statement line items into percentages of a base figure.
• A study by PwC indicated that companies using vertical analysis were 15% more efficient in comparative financial evaluations.
• It’s a simple way to refine forecasts, compare yourself to competitors, and maintain control over your company’s financial health.
• All the line items in a vertical analysis are compared with another line item on the same statement; in the case of an income statement, it is revenue/net sales.
• By comparing vertical analysis results with industry benchmarks, stakeholders can gain insights into a company’s competitive position and operational efficiency.

The primary purpose of vertical analysis is to facilitate the comparison of financial statements over time or between different entities. By presenting each item as a percentage of a total, stakeholders can quickly identify trends, patterns, and anomalies within the data. This method is particularly valuable in assessing the proportion of expenses to revenues, enabling analysts to evaluate operational efficiency and profitability. Furthermore, vertical analysis aids in identifying areas that may require further investigation or adjustment.

This analysis gives the company a heads up if cost of goods sold or any other expense appears to be too high when compared to sales. Reviewing these comparisons allows management and accounting staff at the company to isolate the reasons and take action to fix the problem(s). Vertical analysis is a valuable tool for investors who are looking to gain insight into a company’s performance over time. By comparing different items on the income and cash flow statements, you can get an idea of how the company manages its resources and identify potential opportunities or risks. In order to do a vertical analysis of a company’s cash flow statement, you will need to divide each item by the total net cash from operating activities.

Analyze the percentages to detect trends, assess cost efficiency, and identify areas of concern. For instance, if operating expenses represent a high how to prepare a vertical analysis percentage of revenue compared to prior periods or industry standards, it may signal inefficiencies. Similarly, low percentages in areas like net income or asset liquidity may indicate financial stress. The first step in vertical analysis is to select the appropriate financial statement based on the focus of your analysis. If you’re evaluating profitability and expenses, choose the income statement. If you’re looking at the company’s financial structure and asset composition, opt for the balance sheet.

Kenneth W. Boyd has 30 years of experience in accounting and financial services. He is a four-time Dummies book author, a blogger, and a video host on accounting and finance topics. The following figure is an example of how to prepare a horizontal analysis for two years. For useful trend analysis, you need to use more years (most investors use five), but this example gives you all the info you need to prepare a horizontal analysis for an unlimited number of years. When you understand how each cost or revenue item contributes to overall results, you can find trends, make better budgets, and stay competitive.

Key Learning Points

This formula is applied consistently to all line items, providing a standardized view of each item’s significance relative to the base figure. By using vertical analysis we can look at the proportional contribution of each cost (COGS, marketing, salaries, etc) and analyze which are having a significant impact on profitability. It is a simple and consistent method that can be used year on year and also compare different companies. By being able to measure which cost areas of the business are rising (falling) as a proportion of sales, one can then look at the contributing factors in more detail. As noted before, we can see that salaries increased to 22% as a percentage of total sales in Year 3, compared to 20% in year 2. We can also view from this table that marketing expenses as a percentage of total sales increased to 8% as a percentage of total sales in year 3, compared to 6% in year 2.

On the balance sheet, vertical analysis shows each item as a percentage of total assets. With total assets of $20 million and inventory valued at $6 million, inventory makes up 30% of ACME’s assets. This helps the finance team see how much of their resources are tied up in inventory compared to other assets like cash or receivables. On an income statement for a company with Rs. 100 crores total revenue, if cost of goods sold was Rs. 60 crores and operating expenses were Rs. 20 crores, the vertical analysis percentages would be.