Vertical Analysis: Definition, Formula & Examples

For example, through vertical analysis, we can assess the changes in the working capital or fixed assets (items in balance sheet) over time. Vertical analysis, also known as common-size analysis, is a technique used to assess the relative proportions of different line items within a financial statement. This allows for meaningful comparisons and identification of trends over time or across companies. For instance, a vertical analysis of an income statement might reveal that a company is spending a higher percentage of its revenue on marketing expenses compared to its competitors.

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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. The significance of vertical analysis accounting is well-established in businesses irrespective of their size or stature. Financial statements that include vertical analysis clearly show line item percentages in a separate column. 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, also known as common-size analysis, is a powerful tool used in finance to gain insights into the financial health and performance of a company.

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• To perform such analysis, one needs to create a common size financial statement (for example, a common size income statement).
• To deepen your understanding of vertical analysis, let’s explore some practical examples that demonstrate its application in analyzing financial statements.
• Given the consistent sales growth from year 1 to year 3, it is not surprising that salaries and the marketing expenses of the company have also risen as personnel and marketing spend generally supports sales growth.
• 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.
• It offers a clear lens through which to view a company’s financial health and operational efficiency.
• Like any financial calculation and analysis, vertical analysis is not complete by itself and has pros and cons.

Given the consistent sales growth from year 1 to year 3, it is not surprising that salaries and the marketing expenses of the company have also risen as personnel and marketing spend generally supports sales growth. However these expenses, at the first glance, don’t seem to be significant enough to account for the large fall in net income in year 3. Horizontal analysis might be comparing the ratio of variable expenses over a period of three years. That means the variable expenses in the balance sheet of year 2 and 3 are shown as a percentage of variable expenses of year 1. 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. The following examples demonstrate how to do a vertical analysis using these free balance sheet template and income statement template.

Vertical vs. Horizontal Analysis

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. Through careful interpretation of vertical analysis results, you can gain valuable insights into a company’s financial performance, strengths, and areas for improvement. Overall financial performance is usually analyzed with horizontal or ratio comparison tools. To increase the effectiveness of vertical analysis, multiple year’s statements or reports can be compared, and comparative analysis of statements can be done. This analysis makes it easier to compare the financial statements of one company with another and across the companies as one can see the relative proportion of accounts. This technique fosters informed decision-making and strategic planning, vital for sustained success in today’s competitive financial landscape.

Vertical analysis allows you to benchmark a company’s financial performance against industry averages or leading competitors. By comparing the percentages of line items, you can identify areas of strength or weakness and gain insights into competitive positioning. By analyzing these profitability ratios using vertical analysis, you can gauge a company’s financial performance and compare it to industry benchmarks or previous periods.

Key Differences

It involves comparing each line item or component vertical analysis definition within a financial statement to a specific base figure, usually expressed as a percentage. By converting financial statement entries into percentages of a base figure, it allows for a more standardized form of comparison. Investors, managers, and analysts use vertical analysis to identify trends in operational performance, make intra-firm comparisons, and gauge financial health against industry standards. This percentage can be used to compare both balance sheet and income statementperformance within the company.

By applying vertical analysis to your financial statements, you can gain valuable insights into the composition and distribution of your company’s assets, liabilities, and income. These insights can then guide your decision-making process when it comes to resource allocation, strategic planning, and overall financial management. The first step of vertical analysis is to make a new income statement, such as the common size income statement stated below.

It’s a technique used in financial statement analysis and is often combined with horizontal analysis. Vertical analysis is the comparison of financial statements by representing each line item on the statement as a percentage of the total amount. In this example, we have expressed each line item as a percentage of the revenue, which serves as the base figure. By doing so, we can analyze the proportions and relationships between different components of the income statement. Vertical analysis makes it much easier to compare and contrast the financial statements of different companies.

Financial statement composition

• Horizontal analysis, also known as trend analysis, compares historical data on a financial statement over different accounting periods.
• That means the variable expenses in the balance sheet of year 2 and 3 are shown as a percentage of variable expenses of year 1.
• Based on competitor or industry analysis they can decide if they need to improve one of their categories in the balance sheet, and then make a plan for how to go about doing it.
• This shows that the amount of cash at the end of 2018 is 141% of the amount it was at the end of 2014.
• It is used to assess a business’s ability to grow its revenue while managing its expenses and to get an idea of how efficient the business is at using its assets, liabilities, and various sources of cash.
• 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.
• The following examples demonstrate how to do a vertical analysis using these free balance sheet template and income statement template.

Much like ratio analysis, vertical analysis allows financial information of a small company to be compared with that of a large company. The common size percentage can also be used to compare different companies within the same industry or companies that use different currencies. Vertical analysis is the proportional analysis of a financial statement, where each line item on a financial statement is listed as a percentage of another item. This means that every line item on an income statement is stated as a percentage of gross sales, while every line item on a balance sheet is stated as a percentage of total assets.