Skip to main content
Uncategorized

Vertical Analysis Definition, Overview & Examples

By August 8, 2024January 17th, 2025No Comments

vertical analysis definition

Horizontal analysis, also known as trend analysis, compares historical data on a financial statement over different accounting periods. There is a baseline period and numbers from succeeding periods are calculated as a percentage of the base period. Vertical analysis looks at numbers in financial statements in the same period and calculates each line item as a percentage of the base figure in that section. Vertical analysis of financial statements is also very useful in analyzing key trends over time.

vertical analysis definition

Key Differences

vertical analysis definition

By grasping the purpose, importance, and various components of vertical analysis, you can harness its full potential in financial analysis and decision-making. In this guide, we will explore the concept of vertical analysis, its purpose, and why it is crucial in financial analysis. We’ll dive into the methodology of vertical analysis and walk you through the step-by-step process of conducting a vertical analysis. By the end of this guide, you’ll be equipped with the knowledge to interpret vertical analysis results and apply them in practical scenarios. The solution to this problem is to use percentages based on standard sizes, which also makes it simpler to compare different types of businesses. However, note that vertical analysis can still be used to compare line items’ percentage changes from one quarter or year to the next.

Vertical analysis formula

The common size Fraction is also useful for comparing businesses that operate in the same industry but use different currencies or those that operate in a completely different industry. This approach is helpful since it quickly and clearly breaks down the financial statements’ graphs and charts of various account balances as a proportion of the whole. If, for example, the rationale being utilized on the income statement is revenue, then each piece of data will be expressed as a percentage of the revenue being used. Financial statement items are reported as percentages of one another to facilitate vertical analysis. This step is taken in order to ensure that the analysis is carried out in the most thorough manner possible. When looking at the financial statements of your business, it can get quite confusing due to the different figures used.

In the 3rd year, the COGS decreased compared to the previous years, and the income increased. Example of the vertical analysis accounting of the financial statement, which shows the total amount and percentage. Compares figures from multiple years to identify trends, looking at changes over time in different elements of the financial statements. This shows that the amount of cash at the end of 2024 is 141% of the amount it was at the end of 2020. From this analysis, we can observe that the gross profit margin is 50%, indicating that 50% of the sales revenue is retained after deducting the cost of goods sold.

Understanding Financial Statements

For example, if the cost of goods sold has a history of being 40% of sales in each of the past four years, then a new percentage of 48% would be a cause for alarm. The primary vertical analysis definition difference between vertical analysis and horizontal analysis is that vertical analysis is focused on the relationships between the numbers in a single reporting period, or one moment in time. Horizontal analysis allows investors and analysts to see what has been driving a company’s financial performance over several years and to spot trends and growth patterns. This type of analysis enables analysts to assess relative changes in different line items over time and project them into the future.

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 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. Vertical analysis makes it much easier to compare the financial statements of one company with another and across industries. As noted before, we can see that salaries increased to 22% as a percentage of total sales in Year 3, compared to 20% in year 2.

Multi-year comparisons

For example, upper management may ask “how well did each geographical region manage COGS over the past four quarters? This type of question guides itself to selecting certain horizontal analysis methods and specific trends or patterns to seek out. 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.

  • For example, the total company-wide revenue last quarter might have been $75 million, while the total company-wide revenue this quarter might be $85 million.
  • Vertical analysis is a kind of financial statement analysis wherein each item in the financial statement is shown in the percentage of the base figure.
  • We can easily understand that the total expenses gradually increased from 43% to 52%, and the net income get reduced from 1st year to 2nd year.
  • Discover the key financial, operational, and strategic traits that make a company an ideal Leveraged Buyout (LBO) candidate in this comprehensive guide.
  • The vertical analysis formula, also known as the common-size ratio, is a way to express each line item on a financial statement as a percentage of a base amount.

Calculate Line Items as % of Total

The same can be done with the income statement, where the previous years can be compared and find out the change in the working capital and fixed assets over time. In the above vertical analysis example, we can see that the income decreases from 1st year to 2nd year, and the income increases to 18% in the 3rd year. So by using this method, it is easy to understand the net profit as it is easy to compare between the years. We can easily understand that the total expenses gradually increased from 43% to 52%, and the net income get reduced from 1st year to 2nd year.

Vertical Analysis Formula Explained in Video

  • The cash flow statement tracks the inflows and outflows of cash in a company during a given period.
  • Vertical analysis can guide decision-making processes by providing insights into the financial implications of various options.
  • 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.
  • Though this is dependent on what you are attempting to measure as different financial documents will have different base figures.
  • Vertical analysis makes it easier to compare companies with different levels of sales or assets by expressing them as percentages rather than absolute amounts.
  • Last, a horizontal analysis can encompass calculating percentage changes from one period to the next.
  • Vertical analysis helps assess a company’s financial performance and efficiency by examining the proportions of key line items.

Learn the definition of vertical analysis in finance, how it works, and get a clear example to understand this concept better. By doing both of these analyses, you can get an idea of how line items compare to themselves over time and whether those changes make sense in the context of the current time period as well. This would mean that the ratio of years 1, 2, and 3 to year one would be 100%, 97%, and 94%. In this example, the business’s variable expenses have trended downward over the three-year period. Vertical analysis can also be used to compare the companies numbers to competitors or the industry averages.

You’ll need to choose a point of reference before you can input that number into the equation for vertical analysis. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career. Looking to streamline your business financial modeling process with a prebuilt customizable template?

A vertical analysis is also the most effective way to compare a company’s financial statement to industry averages. Using actual dollar amounts would be ineffective when analyzing an entire industry, but the common-sized percentages of the vertical analysis solve that problem and make industry comparison possible. 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. To perform a horizontal analysis, you must first gather financial information of a single entity across periods of time. Most horizontal analysis entail pulling quarterly or annual financial statements, though specific account balances can be pulled if you’re looking for a specific type of analysis.

Leave a Reply

Close Menu

GOLD ATLANTIC

207 Regent Street
3rd Floor
London, W1B 3HH, UK

GSM: +44-7546 904 493
Phone: +44-7546 904 493
E-mail: [email protected]