Vertical Analysis: What It Is and How It Can Help You Understand Your Financial Position

One of its cons is that it doesn’t take into consideration absolute numbers; so if you are comparing two companies, looking at percentages will give a different result than absolute numbers. By analyzing these ratios using vertical analysis, you can gain insights into a company’s cash flow management and capital allocation strategies. Vertical financial statement analysis can also be used in forecasting and trend analysis.

While performing a vertical analysis, every line item on a financial statement is entered as a percentage of another item. For example, on an income statement, every line item is stated in terms of the percentage of gross sales. In summary, Vertical Analysis provides a valuable lens through which we can dissect financial statements, uncover trends, and make informed decisions. Remember that it complements other analytical tools and should be used alongside horizontal analysis (comparing data over time) and ratio analysis. This percentage can be used to compare both balance sheet and income statementperformance within the company.

Vertical analysis is said to get its name from the up and down motion of your eyes as you scan the common-size financial statements during the analysis process. Most often, vertical analysis is used by management to find changes or variations in financial statement items of importance like individual asset accounts or asset groups. Both techniques provide valuable insights for financial analysis and decision-making, but they serve different purposes and offer distinct perspectives on a company’s financial performance. The above vertical analysis example shows the company’s net profit where we can see the net profit in both amount and percentage. The income statement can be vertical analysis is also known as compared with previous years, and the net income can be compared where it helps to compare and understand the percentage of rising or loss of income. Both vertical and horizontal analysis methods provide valuable information/insights.

Understanding Financial Statements

1. It is called a vertical analysis because you analyze the percentage numbers in a vertical fashion.
2. By leveraging these practical applications, you can harness the power of vertical analysis to enhance financial decision-making and improve overall business performance.
3. Vertical analysis is exceptionally useful while charting a regression analysis or a ratio trend analysis.
4. Such analysis provides us with comparable percentages that can be used for comparison of financial statements with the previous years.
5. For example, if you see the various expense line items in the income statement as a percentage of sales.
6. The purpose of vertical analysis is to provide insights into the distribution and significance of various components within a financial statement.

By analyzing the historical trends and proportions of line items, analysts can project future performance and identify potential areas of concern. This information assists in developing financial forecasts, budgeting, and strategic planning. Vertical analysis provides a holistic view of a company’s financial structure, allowing us to compare apples to apples across industries. Whether analyzing trends, benchmarking, or understanding financial ratios, this technique empowers decision-makers to make informed choices. Remember, context matters—consider both industry norms and company-specific factors when interpreting verticals. In summary, vertical analysis provides a valuable perspective on financial data, enabling stakeholders to make informed decisions.

Vertical Analysis Methodology

Vertical analysis assesses the relative representation of each financial statement line item by expressing them as percentages of total sales. Meanwhile, horizontal analysis examines changes over time in financial elements, aiding in identifying performance trends. Employing both vertical and horizontal analyses provides a holistic understanding of a business’s financial position and performance. This approach aids the swift identification of correlations by showing the proportion of various account balances in the financial statements. Furthermore, vertical analysis streamlines the comparison of different companies operating within the same industry.

Horizontal Analysis

For example, by comparing the percentages of cost of goods sold and operating expenses, analysts can determine the efficiency of a company’s operations. 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. In the realm of finance, vertical analysis aids in comparing the composition of income and expenses over time or against industry peers.

Let us understand the advantages of vertical analysis equation through the points below. For each line item on the balance sheet, divide it by the Total Assets and multiply the result by 100. Let’s look at an example to see how applying the vertical analysis formula might work in the real world. CFI is the global institution behind the financial modeling and valuation analyst FMVA® Designation. CFI is on a mission to enable anyone to be a great financial analyst and have a great career path. In order to help you advance your career, CFI has compiled many resources to assist you along the path.