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Vertical Analysis Definition How It Works and Example

Vertical Analysis Definition How It Works and Example

Vertical Analysis: Definition, How It Works, and Example

Mitchell Grant is a self-taught investor with over 5 years of experience as a financial trader. He is a financial content strategist and creative content editor.

What Is Vertical Analysis?

Vertical analysis is a method of financial statement analysis in which each line item is listed as a percentage of a base figure within the statement. Line items on an income statement can be stated as a percentage of gross sales, while line items on a balance sheet can be stated as a percentage of total assets or total liabilities. Vertical analysis of a cash flow statement shows each cash inflow or outflow as a percentage of the total cash inflows.

Key Takeaways

  • Vertical analysis makes it easier to understand the correlation between line items on a balance sheet and the bottom line, expressed as a percentage.
  • Vertical analysis becomes a more potent tool when used in conjunction with horizontal analysis, which considers the finances of a certain period of time.

How Vertical Analysis Works

Vertical analysis makes it easier to compare the financial statements of one company with another, and across industries, by showing the relative proportions of account balances. It also facilitates time series analysis by comparing quarterly and annual figures over multiple years to assess whether performance metrics are improving or deteriorating.

For example, by showing expense line items in the income statement as a percentage of sales, one can assess their impact on profit margins and observe trends in profitability. This allows for easy comparison of a company’s profitability with its peers.

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Financial statements incorporating vertical analysis display line item percentages in a separate column. These types of financial statements, called common-size financial statements, provide greater detail on a company’s financial position and often include columns for comparing each line item to a previously reported period.

Vertical analysis helps in gaining insights about performance metrics improvement or deterioration.

Vertical vs. Horizontal Analysis

Another form of financial statement analysis used in ratio analysis is horizontal analysis or trend analysis. This involves comparing ratios or line items in a company’s financial statements over a certain period of time, using one year as a baseline and expressing changes to that baseline as percentage differences in subsequent years.

For example, the amount of cash reported on the balance sheet on Dec. 31 of 2018, 2017, 2016, 2015, and 2014 can be expressed as a percentage of the Dec. 31, 2014, amount. Instead of dollar amounts, you might see 141, 135, 126, 118, and 100.

This demonstrates that the amount of cash at the end of 2018 is 141% of the amount at the end of 2014. Performing the same analysis for each item on the balance sheet and income statement reveals changes in relation to other items.

Example of Vertical Analysis

Suppose XYZ Corporation has gross sales of $5 million, cost of goods sold of $1 million, general and administrative expenses of $2 million, and a 25% tax rate. When vertical analysis is applied, its income statement looks like this:

Sales 5,000,000 100%
Cost of goods sold 1,000,000 20%
Gross profit 4,000,000 80%
General and Administrative Expenses 2,000,000 40%
Operating Income 2,000,000 40%
Taxes (%25) 500,000 10%
Net income 1,500,000 30%
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Sales 5,000,000 100%
Cost of goods sold 1,000,000 20%
Gross profit 4,000,000 80%
General and Administrative Expenses 2,000,000 40%
Operating Income 2,000,000 40%
Taxes (%25) 500,000 10%
Net income 1,500,000 30%

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