Vertical Analysis Overview
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. Typically, 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.
The most common use of vertical analysis is within a financial statement for a single time period, so that you can see the relative proportions of account balances. Vertical analysis is also useful for timeline analysis, where you can see relative changes in accounts over time, such as on a comparative basis over a five-year period. 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.
Vertical Analysis of the Income Statement
The most common use of vertical analysis in an income statement is to show the various expense line items as a percentage of sales, though it can also be used to show the percentage of different revenue line items that make up total sales. An example of vertical analysis for an income statement is shown in the far right column of the following condensed income statement:
|Cost of goods sold||400,000||40%|
|Salaries and wages||250,000||25%|
The information provided by this income statement format is useful not only for spotting spikes in expenses, but also for determining which expenses are so small that they may not be worthy of much management attention.
Vertical Analysis of the Balance Sheet
The central issue when creating a vertical analysis of a balance sheet is what to use as the denominator in the percentage calculation. The usual denominator is the asset total, but you can also use the total of all liabilities when calculating all liability line item percentages, and the total of all equity accounts when calculating all equity line item percentages. An example of vertical analysis for a balance sheet is shown in the far right column of the following condensed balance sheet:
|Total current assets||600,000||60%|
|Total current liabilities||250,000||25%|
|Total liabilities and equity||$1,000,000||100%|
The information provided by this balance sheet format is useful for noting changes in a company's investment in working capital and fixed assets over time, which may indicate an altered business model that requires a different amount of ongoing funding.