Vertical Analysis Financial Accounting

Another form of financial statement analysis used in ratio analysis is horizontal analysis or trend analysis. Vertical analysis, also known as common-size analysis, is a financial analysis technique used to evaluate the relative proportions of different line items within a financial statement. It involves expressing each line item as a percentage of a base figure, typically taken as 100%. This approach allows for meaningful comparisons of line items over time or across companies, highlighting changes in the composition and structure of financial statements.

Each common-size line item is the percent of total assets that the line item’s dollar value represents. In addition, vertical analysis can aid in financial forecasting by projecting future trends based on historical data. By analyzing the percentages of line items, you can make informed predictions and support strategic planning. By analyzing these ratios using vertical analysis, you can gain insights into a company’s cash flow management and capital allocation strategies.

Vertical Analysis Formula, Calculation & Purpose

It can be used to compare the company’s performance within one year, year on year, against budgeted expectations, or against competitors. In vertical analysis each line item in the income statement is converted to a percent of total assets. By examining these vertical percentages, analysts can evaluate the cost structure, profitability ratios, and the relative significance of different line items within the income statement. In this example, we have expressed each line item as a percentage of the revenue, which serves as the base figure.

This involves staying up to date with industry trends and evolving financial practices, as well as evaluating the outcomes of decisions influenced by this analysis. Just like any financial statement analysis method, vertical analysis isn’t a one-time task. The ratios that made sense for employee salaries in the tech sector in 2005, for instance, wouldn’t have been applicable in 2017. It can be used in the same way, vertical analysis formula identifying whether the current balance matches the strategy of the business, as well as looking at multiple years to identify trends and anomalies. For example, it can be an easy way to track how much of the balance sheet is held in illiquid assets, or to assess how the debt structure has been changing over time. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more.

Types of Common Size Analysis

It can be hard to compare the balance sheet of a $1 billion company with that of a $100 billion company. The common-sized accounts of vertical analysis make it possible to compare and contrast numbers of far different magnitudes in a meaningful way. By doing this, we’ll build a new income statement that shows each account as a percentage of the sales for that year. As an example, in year one we’ll divide the company’s “Salaries” expense, $95,000 by its sales for that year, $400,000.

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Using Vertical Analysis for Benchmarking and Industry Comparisons

While horizontal analysis is concerned with variable change over time, vertical analysis focuses on the proportion each item represents for the whole amount in a single period. Hence why it’s called vertical analysis – you add your calculations vertically next to each item. Since these proportions are expressed as percentages, you can easily compare them to other time periods or other companies. The most common use of vertical analysis is within a financial statement for a single reporting period, so that one can see the relative proportions of account balances. Vertical analysis is also useful for trend analysis, to see relative changes in accounts over time, such as on a comparative basis over a five-year period.

This rose sharply to 52% of sales in year 3 (from 41% and 44% in year 2 and year 1 respectively). The effectiveness of vertical analysis will vary from one business to another. It’s a key responsibility of the FP&A team to keep track of this and foresee how different strategies might affect the company’s finances in the long run. One of the major benefits of vertical analysis is that it makes it simple to report to and communicate with stakeholders. A ratio-based approach makes it easy to provide a clear picture of financial health, with very little need for background information or detailed notes. This simplicity and clarity enables efficient evaluation of a company’s financial health and performance, leading to more effective strategic decision-making by executives.