Gain a deeper understanding of your financial statements with vertical analysis

What is vertical analysis in finance?

Vertical analysis in finance, also known as common size analysis, is a financial statement analysis technique that reports each of a company’s financial items as a percentage of a common base figure. By expressing each item as a percentage or ratio, it is easier to identify and compare business trends over time. Additionally, vertical analysis helps investors determine the relative proportions of each item on the financial statements.

The base figure used in vertical analysis is usually total revenue, but other figures such as total assets or net income can also be used. Once the base figure is selected, the amounts for all other financial statement items are reported as a percentage of that base figure. These percentage results can then be compared on a yearly basis to assess the relative contribution that each element makes to the financial health of the business.

For example, let’s say a business has total revenue of ,000 and total expenses of 0 for a given period. Using vertical analysis with total revenue as the base figure, total expenses can be expressed as 80% of total revenue. Similarly, individual items reported on the expense line, such as rent, wages, and materials, can also be expressed as a percentage of total revenue.

When performing a vertical analysis, it is important to use the same base figure each year so that conclusive understanding can be drawn from the results. In addition, consistency of the reference period should also be ensured, as differences in the year of comparison chosen may produce different results.

To illustrate the usefulness of vertical analysis in finance, here are some examples of how it can be used:

• Determine the cost of goods sold as a percentage of total revenue.
• Comparison of sales of different product lines or geographic location with total revenue.
• Analysis of increased liability due to increased borrowing.
• Highlight changes in the contribution of assets to business success.

Key points to remember:

• Vertical analysis is a financial statement analysis method that evaluates multiple components in a given financial statement.
• It’s about expressing each line item as a percentage of a base, usually the owner’s sales, assets, or equity.
• The goal of vertical analysis is to better understand the business, typically making comparisons to industry ratios and averages, as well as changes from year to year.
• It offers benefits such as quickly identifying existing problems and areas of potential concern, allowing comparisons across financial statements and providing a general understanding of financial statements.
• It also has drawbacks such as not being suitable for assessing the true value of an element of the financial statements and not taking into account external factors.

How does vertical analysis work?

Vertical analysis is a financial technique used to analyze and interpret financial statement information. The purpose of vertical analysis is to show the percentage each line item in a financial statement contributes to the total figure. All components of a financial statement are stated as a percentage of the base figure, usually sales, assets or owner’s equity.

Here is a step-by-step explanation of how to use vertical analysis:

• Step 1: Choose a financial statement to analyze. This generally includes the income statement, balance sheet and the use of cash.
• Step 2: Select a base figure for analysis. This is the comparison figure for other line items in the financial statements. For the income statement, the base figure is usually net sales. For the balance sheet it is often total assets, and for the cash flow account the base figure is net income.
• Step 3: Calculate the percentage of base figure for each financial statement line item. To calculate the percentage of each line item, divide the item number by the base number. Then multiply the answer by 100.
• Step 4: Analyze the results. Review the percentages and compare them to the previous year’s bank statement and industry averages. This comparison can help you identify potential problems within the business and assess the financial health of the business.

Here is an example of a vertical analysis: Barley’s Motors analyzes their income statement. For the year ending December 31, 2020, the net sales figure is ,000. Cost of goods sold is ,000, administrative costs are ,000, and interest on interest is ,000. The net profit is ,000. The following would be the percentages for each line item using the ,000 net sales figure as the base figure:

• Cost of goods sold = ,000 / ,000 = 0.50 or 50%
• Administrative expenses = ,000 / ,000 = 0.14 or 14%
• Fee interest = ,000 / ,000 = 0.06 or 6%
• Net income = ,000 / ,000 = 0.30 or 30%

When performing a vertical analysis, it is important to use the same base figure for each financial statement. For example, if you use total assets as the base figure for the balance sheet, you must also use total assets for the cash flow statement. Also, when comparing returns from different years or industry averages, use the same base numbers for all comparisons.

How to use vertical analysis to evaluate financial statements?

Vertical analysis, also known as common size analysis, is a financial statement analysis method that evaluates multiple components in a given financial statement. This is to express each line item as a percentage of a base. This is usually done by presenting each line item on the income statement and balance sheet as a percentage of total revenue or total assets, respectively. The goal of vertical analysis is to better understand the business, typically making comparisons to industry ratios and averages, as well as changes from year to year.

Examples of vertical analysis calculation:

• Gross profit as a percentage of sales revenue: gross profit / sales revenue x 100
• Accounts Receivable as a Percentage of Total Sales Revenue: Accounts Receivable/Sales Revenue x 100

Tips for using vertical analysis:

• Focus on financial health indicators such as liquidity and profitability ratios.
• Ensure that the base numbers (total sales revenue and total assets) used are correct and consistent throughout the financial statements.
• Make comparisons to industry averages or expectations to understand how a company is performing against its peers.
• Monitor year-over-year changes to track business performance over time.

What are the advantages and disadvantages of using vertical analysis?

Vertical analysis, also known as common size analysis or dollar-based analysis, is a method of analyzing financial statements in which all line items are expressed as a percentage of a figure of base. This helps analysts compare line item sizes from months, years, and even across companies. The following list describes the main advantages and disadvantages of using vertical analysis.

Advantages of vertical analysis

• Quickly identifies existing issues and areas of potential concern: With vertical analysis, all financial statement items are expressed as a percentage of a base figure. This allows analysts to quickly identify potential issues and areas of concern. For example, by applying vertical analysis to a company’s balance sheet, they can compare current liabilities to their fixed assets, allowing them to easily identify any liquidity issues the company may have.
• Easily compare financial statements between quarters or years: Vertical analysis allows analysts to compare financial statements from different quarters or years. This is useful for tracking a company’s progress over time. For example, vertical analysis can be used to compare revenue statements from year to year, allowing analysts to identify trends or changes in revenue sources.
• Provides a general understanding of financial statements: Vertical analysis makes it easier for analysts to obtain a comprehensive understanding of financial statements. This is especially important for investors, who need to understand the fundamentals of a business before investing.

Disadvantages of vertical analysis

• Does not indicate the dollar value of the item: The disadvantage of using vertical analysis is that it is not suitable for assessing the actual dollar or euro value of an item of financial state. For example, while it’s easy to compare the relative size of a company’s operating expenses, it doesn’t indicate what those expenses were actually worth.
• Does not take into account external factors: Vertical analysis does not take into account external factors or macroeconomic conditions. For example, although it can easily be used to compare the cost of goods sold between two periods, it gives no insight into changes in the macroeconomic environment that may have impacted these costs.

Overall, vertical analysis is a useful tool for analyzing financial statements. It is useful for quickly identifying existing problems and comparing financial statements between different periods. However, it has some drawbacks and should not be used in isolation to assess the real dollar value of a line item or to assess the impact of macroeconomic conditions.

How is vertical analysis used to compare companies?

Vertical analysis (also known as common size analysis) is a tool used in financial analysis to normalize financial statements by expressing line items as a percentage of a base figure. This allows financial data, such as income statements, balance sheets, and cash flow statements, to be compared across different companies, time periods, and across industry sectors, making it a versatile and powerful tool for the comparisons.

It is an important tool for financial analysis because using actual amounts in comparison can be misleading due to different business sizes and financial situations.

The base figure is usually the total of the analyzed line. For example, by expressing each line item on an income statement as a percentage of total revenue, it provides a direct comparison between different revenue components as a percentage of total sales. The same approach can be used for other financial reports by expressing each line item as a percentage of the report’s corresponding total.

By performing a vertical analysis on the financial statements, key trends and relationships can be identified, such as changes in costs, expenses and total sales or variations in the cost of goods sold between companies. It can also be used to compare the relative sizes of different line items in a financial statement.

For example, a vertical analysis on an income statement would provide a percentage representation of each line item (e.g. cost of goods sold, operating expenses, etc.) against the total sales amount. This gives a comprehensive overview of how businesses are performing and areas that may need more attention. It can also be used to identify growth and cost opportunities and compare companies in the same industry.

The following tips may be useful for performing a vertical analysis when comparing companies:

• Calculate the percentages for each financial statement line item.
• Compare percentage-based figures between companies to identify trends.
• Look for outliers that may warrant further investigation.
• Examine the relationships between the various financial statement line items.
• Check for changes in business fundamentals over a period of time.
• Compare companies to industry averages to identify opportunities for improvement.

What elements are typically included in vertical analysis?

Vertical analysis is a technique for analyzing financial statements where all entries in the financial statements are expressed as a percentage of a base figure. It is used to compare items or trends over time or between different companies or regions. Items typically included in vertical analysis include:

• Balance sheet
• income statement
• Cash flow account

For each of these statements, all items are expressed as a percentage of total assets, total sales or total net income. For example, in a vertical balance sheet analysis, each balance sheet item is expressed as a percentage of total assets. To calculate the percentage, you divide the balance of each item by the total assets and multiply by 100. In a vertical income statement analysis, each item in the income statement is expressed as a percentage of total sales. To calculate the percentage, you divide the balance of each item by the total sales and multiply by 100. Finally, in a vertical cash flow analysis, each item in the cash flow statement is expressed as a percentage of total net profit . To calculate the percentage, you divide each item’s balance by the total net profit and multiply by 100. Analyzing financial statements in this way makes it easier to identify trends in financial transactions and positions. It can allow for a more comprehensive comparison between companies and provide insight into a company’s performance over time. It also helps to identify areas for improvement or areas of concern. When performing a vertical analysis, it is important to prioritize and focus on key financial areas that could be indicative of a company’s overall performance. For example, the ratio of current liabilities to sales can be a very effective and important metric for valuing a business. By taking the extra measure of anaData lysis Using vertical analysis, companies can gain invaluable insights into their performance and operations.

What are the limits of vertical analysis in finance?

Vertical analysis is a popular budgeting and financial management management tool used globally to analyze different components of a company’s financial statements, such as its balance sheet and income statement. However, like any tool, vertical analysis has certain limitations that should be taken into consideration before using it. These limitations include:

• Unreliable comparisons: When analyzing different years of financials using vertical analysis, the comparison may be unreliable because the financials may not be indicative of an apples-to-apples comparison if the sales volume of one year is much higher than the other.
• Lack of absolute data: Vertical analysis does not provide absolute data, which makes it difficult to assess a company’s absolute performance.
• Misleading results: Vertical analysis can be misleading for inexperienced investors because it is based on percentages only and ignores actual dollar amounts.
• Multiple interpretations: Each individual may interpret a vertical scan in a different way. This can lead to discrepancies if several people evaluate the same data.

Tips for maximizing the benefits of vertical analysis include:

• Balance the numbers: Make sure the numbers provided in the financial statements are balanced. This will ensure the accuracy and reliability of the figures used for the vertical analysis.
• Include historical data: Include multiple years of financial statements to find meaningful trends in data. This will provide better assurance of business performance.
• Check the data: it is important to check the referenced data used for the vertical analysis for any discrepancies that could lead to misinterpretations.

Conclusion:

Overall, vertical analysis is a useful tool for analyzing financial statements. It is useful for quickly identifying existing problems and comparing financial statements between different periods. However, it has some drawbacks and should not be used in isolation to assess the real dollar value of a line item or to assess the impact of macroeconomic conditions.