Vertical Analysis? Definition, Formula, and Examples

Vertical common size analysis provides a valuable tool for FP&A professionals to gain insights into the composition, trends, and relationships within a company’s financial statements. Through FP&A tools, you can simplify vertical analysis by conducting faster calculations, incorporating the values into visually appealing charts, forecasting your company’s future through analysing historical data. Another form of financial statement analysis used in ratio analysis is horizontal analysis or trend analysis. The technique can be used to analyze the three primary financial statements, i.e., balance sheet, income statement, and cash flow statement. In the balance sheet, the common base item to which other line items are expressed is total assets, while in the income statement, it is total revenues.

We already established that vertical analysis looks at the proportional representation of specific line items on financial statements by comparing them as a percentage of the total. Here, the Total Revenue is considered 100%, and all other figures are expressed as a percentage of this total. This vertical analysis shows that the company’s Cost of Goods Sold is 40% of the total revenue, leaving a gross profit margin of 60%. Operating expenses account for 25% of the total revenue, resulting in an operating income of 35%. After accounting for interest and taxes, the net income is 21% of the total revenue, providing a clear picture of the company’s profitability.

Step 3: Identify Trends and Patterns

Cash, for instance, makes up 15% of total assets, while equipment represents a significant 40%. Similarly, total liabilities are 40% of total assets, with long-term debt making up 30%. This vertical analysis provides insights into the company’s financial structure and the proportion of financing coming from debt versus equity. So, in a vertical analysis of a balance sheet, every line item — cash, accounts receivable, fixed assets, accounts payable, stockholders equity, etc. — is shown as a percentage of total assets. In a vertical analysis of an income statement, every line item is shown as a percentage of gross sales. Vertical analysis is a method where each line item on a financial statement is represented as a percentage of a base figure.

1. For the income statement, this base is typically total revenue or sales, while for the balance sheet, it’s total assets (for the asset side) and total liabilities plus equity (for the liabilities and equity side).
2. In the realm of financial analysis, understanding the relative significance of each line item in a financial statement is crucial.
3. When analysts compare various companies at the same time it allows them to normalize items like total income and net income across businesses of various sizes.
4. Each of these statements offers unique perspectives on a company’s financial situation.
5. For example, some minor adjustments could be to remove the “Revenue (% Revenue)” line item since it is not necessary and offers no practical insights.
6. The process is virtually identical to our common size income statement, however, the base figure is “Total Assets” as opposed to “Revenue”.
7. Let’s look at an example to see how applying the vertical analysis formula might work in the real world.

Step 2: Identify total assets

In this FAQ we will discuss what vertical analysis is, how it relates to horizontal analysis, and provide a simple example of how to apply it. Because we entered our costs and expenses as negatives, i.e. to reflect that those items are cash outflows, we must place a negative sign in front when applicable, so that the percentage shown is a positive figure. So if we had multiple years of historical data, it is recommended to organize the percentage calculations into a single section on the far right or below the financials with the timing of the periods aligned.

1. One of the benefits of using common size analysis is that it allows investors to identify large changes in a company’s financial statements.
2. It enables businesses to gain quick insights into historical performance by comparing current values to previous periods.
3. Common size analysis is used to calculate net profit margin, as well as gross and operating margins.
4. By comparing the proportions of individual accounts from time period to period, companies can track fluctuations and use them to inform strategic decisions, assisting with financial forecasting.
5. For example, upper management may ask “how well did each geographical region manage COGS over the past four quarters?”.
6. This analysis helps see the proportion of each item compared to the net profit, providing insights into where the money is coming from and where it is being spent.
7. Vertical analysis is a technique used in financial statement analysis to show the relative size of each account compared to the total amount.

Additional Resources

First, a direction comparison simply looks at the results from one period and comparing it to another. For example, the total company-wide revenue last quarter might have been $75 million, while the total company-wide revenue this quarter might be $85 million. This type of comparison is most often used to spot high-level, easily identifiable differences. You can choose whatever interval (month-over-month, year-over-year, etc.), but each iterative financial statement should be equal distance away regarding when it was issued compared to other bits of financial information.

What are the Benefits of Common Size Analysis?

The balance sheet common size analysis mostly uses the total assets value as the base value. A financial manager or investor can use the common size analysis to see how a firm’s capital structure compares to rivals. They can make important observations by analyzing specific line items in relation to the total assets. The primary difference between vertical analysis and horizontal analysis is that vertical analysis is focused on the relationships between the numbers in a single reporting period, or one moment in time. Common size analysis is used to calculate net profit margin, as well as gross and operating margins. Common size analysis, also referred to as vertical analysis, is a tool that financial managers use to analyze financial statements.

Most horizontal analysis entail pulling quarterly or annual financial statements, though specific account balances can be pulled if you’re looking for a specific type of analysis. Notice that the column presenting the ratio of each line item to gross sales is to the right of the actual values. Sometimes, financial statements are prepared in this way by the provider but often FP&A analysts will utilize their own basis depending vertical analysis is also known as on what information they are trying to understand. Horizontal analysis differs slightly from vertical analysis in that it presents each item in the financial statements as a percentage of itself at an earlier period in time. A vertical analysis, also known as common-size analysis, is a method of financial statement analysis that shows each line item as a percentage of a base figure within the statement.

In the current year, company XYZ reported a net income of $20 million and retained earnings of $52 million. Consequently, it has an increase of $10 million in its net income and $2 million in its retained earnings year over year. Datarails’ AI FP&A software replaces spreadsheets with real-time data and integrates fragmented workbooks and data sources into one centralized location.

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When comparing a company’s vertical analysis results with industry averages or key competitors, it becomes easier to spot areas of inefficiency or potential competitive advantages. Input the percentage against the line items calculated to see a concise view of each item’s contribution to the gross amount. Creating visually appealing charts such as bar graphs or data tables will make it easier to understand. You simply receive a concise view of your line items without performing complex calculations. Using tools such as Power BI to chart your results, you can visualize your performance and make informed decisions for a successful plan. This financial analysis can help you build a solid financial report by comparing the percentages to the budgeted expectations.

Try it with your next financial analysis and see if it provides useful insights or helps you track progress toward goals. Do you want to take your financial analysis skills to the next level and get more detailed insight into your financial statements? Learning how to perform a vertical balance sheet analysis can equip you with the skills to extract actionable insights into your company’s current financial health. By converting financial statement numbers into percentages, vertical analysis offers a consistent basis for comparison.