Vertical Analysis? Definition, Formula, and Examples

The metric we calculated is formally known as the “debt to asset ratio”, which is a ratio used to gauge a company’s solvency risk and the proportion of its resources (i.e. assets) funded by debt rather than equity. The process is virtually identical to our common size income statement, however, the base figure is “Total Assets” as opposed to “Revenue”. Suppose we’ve been tasked with performing vertical analysis on a company’s financial performance in its latest fiscal year, 2021. Performing vertical analysis creates the so-called “common size” income statement and the “common size” balance sheet. Conceptually, vertical analysis can be thought of as reading a single column of financial data and determining the relationships among each item to reflect the relative size of the various cost and profit metrics. Vertical analysis is exceptionally useful while charting a regression analysis or a ratio trend analysis.

Vertical analysis example (income statement)

For instance, an income statement reveals gross sales figures, a cash flow statement presents total assets and revenues, and a balance sheet displays the total liabilities and assets. When you apply vertical analysis to the balance sheet, you can understand the relative composition of assets, liabilities, and equity. Through accounting ratios, you can compare two-line items in your financial statement and point which items are bringing in more profit. By examining the proportional changes in these components, you can evaluate the company’s financial structure, liquidity, and leverage. It helps identify the impact of changes in asset or liability categories on the overall financial health of the organization. In vertical analysis, each line item in the financial statement is expressed as a percentage of a base figure in the same period (for example, the total assets or gross sales).

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It enables the accountant to see relative changes in company accounts over a given period of time. Previously, Stefan served as the Corporate Controller for Kodiak Cakes, a private equity owned, leading consumer packaged food company, and as a Controller for Skullcandy, a multinational headphone CPG. When used together, they offer a comprehensive view of the company’s financial health. Vertical analysis lets you identify trends, growth areas, and patterns in your financial statements and build well-informed strategic plans.

What Is Horizontal Analysis?

1. When you apply vertical analysis to the balance sheet, you can understand the relative composition of assets, liabilities, and equity.
2. Suppose we’ve been tasked with performing vertical analysis on a company’s financial performance in its latest fiscal year, 2021.
3. Vertical analysis indicates the relative importance of each line item in a certain period.
4. Recognizing the objective will assist you in determining the appropriate foundation for your calculations.
5. The percentage change is calculated by first dividing the dollar change between the comparison year and the base year by the line item value in the base year, then multiplying the quotient by 100.
6. This reveals how business compare in managing their assets and liabilities, income, expenses, and cash flow (regardless of total size).
7. These types of financial statements, including detailed vertical analysis, are also known as common-size financial statements and are used by many companies to provide greater detail on a company’s financial position.

Vertical analysis refers to the analysis of specific line items in relation to a base item within the same financial period. For example, in the balance sheet, we can assess the proportion of inventory by dividing the inventory line using total assets as the base item. When performing vertical analysis each of the primary statements that make up the financial statements is typically viewed exclusive of the other. This means it is atypical to compare line items on the income statement as a percentage of gross income.

Coverage ratios, like the cash flow-to-debt ratio and the interest coverage ratio, can reveal how well a company can service its debt through sufficient liquidity and whether that ability is increasing or decreasing. Horizontal analysis also makes it easier to compare growth rates and profitability among multiple companies in the same industry. Compares figures from multiple years to identify trends, looking at changes over time in different elements of the financial statements. On a balance sheet this might mean showing the percentage of accounts receivable in comparison to the total assets as shown in the example below.

1. Vertical analysis makes it easier to compare companies with different levels of sales or assets by expressing them as percentages rather than absolute amounts.
2. For example, the vertical analysis of an income statement results in every income statement amount being restated as a percent of net sales.
3. The technique can be used to analyze the three primary financial statements, i.e., balance sheet, income statement, and cash flow statement.
4. Common size analysis is also an excellent tool to compare companies of different sizes but in the same industry.
5. By using both vertical and horizontal analyses, businesses can gain a better understanding of their financial position and performance.

Converting the raw numbers into percentages provides a clearer picture of the proportion of the asset or liability in the context of the company’s total financial resources. For instance, we can observe that the cost of goods sold represents 40% of net sales, indicating that the production or procurement of goods consumes 40% of the revenue. The gross profit margin is 60%, suggesting that the company retains 60% of its revenue after deducting the cost of goods sold. Vertical percentage analysis provides a swift means of evaluating your past performance by comparing your current figures to those of the past.

For example, on the income statement if the base chosen is revenue, then each line item would be shown as a percentage of revenue. The base may also be net income, total gross income, or any other detail of income that you would want to compare. Vertical analysis is a type of ratio analysis that presents each line on the financial statements as a percentage of another item. Vertical analysis is the comparison of financial statements by representing each line item on the statement as a percentage of the total amount. This approach provides insights into patterns over time, highlighting increases, decreases, or trends.

Starting from the revenue line item, each line item on the income statement – if deemed appropriate – is divided by revenue (or the applicable core metric). Read on to learn more about vertical analysis of a balance sheet, how to perform one, and some limitations and drawbacks of this analytical tool. By understanding the proportional significance of various expenses or investments, CFOs and CEOs can make informed decisions about resource allocation, cost-cutting, or strategic investments. Would you like to review the financial performance from the past months/years or demonstrate your business’s financial health to stakeholders?

A) When ratios of previous years are compared with current years, they are called trend ratios. Vertical analysis (also known as common-size analysis) is a financial statement analysis technique that shows each line item on a financial statement as a percentage. Let’s look at vertical analysis in more detail, explore how it works and examine the differences between vertical analysis and horizontal analysis. Here, we’ve chosen “Revenue” as the base vertical analysis is also known as figure for the common size income statement, followed by “Total Assets” for the common size balance sheet. To start, the table below shows the company’s historical financial statements – the income statement and balance sheet – of our hypothetical company, which we’ll be using throughout our two-part exercise.

By comparing prior-period financial results with more current financial results, a company is better able to spot the direction of change in account balances and the magnitude in which that change has occurred. Last, a horizontal analysis can encompass calculating percentage changes from one period to the next. As a company grows, it often becomes more difficult to sustain the same rate of growth, even if the company grows in pure dollar size. This percentage method is most useful when identifying changes over a longer period of time where there may be significant deviations from the base period to the current period. For instance, we can see that our company’s long-term debt as a percentage of total assets is 17.0%.

If the company wants to use vertical analysis to see how their AR is doing, they would calculate AR in percentage of their entire balance sheet which would be 25% ($100,000 of $400,000). If they want to calculate their inventory, it would be 20% while using vertical analysis ($80,000 of the $400,000 total). While each financial statement is viewed differently and the ratios are compared on a different basis, it is common to see the methodology prepared in this way. That being said, there are some circumstances where cross comparing ratios of certain accounts would make sense. That is because this approach quickly reveals the proportion of various account balances reflected in the financial statements. That’s $100,000 in cash plus $40,000 in accounts receivable plus $50,000 of fixed assets.