Corporate Finance Explained: Analyzing Financial Statements CFI

Vertical analysis is the comparison of financial statements by representing each line item on the statement as a percentage of another (base) line item. Vertical analysis is a method of financial analysis where each line item is listed as a percentage of a base figure within the statement. By analyzing these ratios using vertical analysis, you can evaluate a company’s financial position, leverage, and liquidity. By using vertical analysis we can look retained earnings at the proportional contribution of each cost (COGS, marketing, salaries, etc) and analyze which are having a significant impact on profitability. It is a simple and consistent method that can be used year on year and also compare different companies. By being able to measure which cost areas of the business are rising (falling) as a proportion of sales, one can then look at the contributing factors in more detail.

Everything You Need To Master Financial Modeling

Vertical Analysis is a form of financial analysis where the line items on a company’s income statement or balance sheet is expressed as a percentage of a base figure. The balance sheet uses the total assets or liabilities as the starting point in the vertical analysis. In contrast, the income statement uses total revenue or sales as the starting point.

Return on Assets (ROA)

Thus, it provides insight into the business’s performance and financial structure. Vertical Analysis of the income statement shows the revenue or sales number as 100% and all other line items as a percentage of sales. All the line items in a vertical analysis are compared with another line item on the same statement; in the case of an income statement, it is revenue/net sales.

Finance and Accounting for the Nonfinancial Professional

• The first step of vertical analysis is to make a new income statement, such as the common size income statement stated below.
• By grasping the purpose, importance, and various components of vertical analysis, you can harness its full potential in financial analysis and decision-making.
• Furthermore, by accessing up-to-date data, you can make informed decisions based on a comprehensive understanding of your financial performance.
• Such a breakdown helps decision-makers assess liquidity, debt levels, and overall financial stability, guiding strategic decisions regarding capital structure and risk management.
• Such shifts can point to operational improvement opportunities or highlight areas of investment needed for long-term growth.

For example, the amount of cash Car Dealership Accounting reported on the balance sheet on Dec. 31 of 2024, 2023, 2022, 2021, and 2020 will be expressed as a percentage of the Dec. 31, 2020, amount. Unlock the secrets within these statements, and we haveto use things like ratio analysis. After you have crunched the numbers, it is important to take a step back and interpret your results. Look for any trends or changes in the ratios that may indicate a shift in performance. This could indicate potential opportunities or threats that may arise in the future. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping.

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. Given below is an example, where we have the income statement of a company (in US dollars). We can gather from the data below that the sales of the company increased consistently from year 1 to year 3. However, while sales rose consistently from year 1 to 3, net income dropped markedly in year 3 so we would like to look into this in more detail.

This allows standardized comparisons across vertical analysis periods or between companies of varying sizes. 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. This type of analysis in accounting is only one technique which can be used to analyze financial information.

Vertical Analysis Income Statement: How to Spot Financial Trends

• First, select a base figure for each financial statement—total sales for the income statement, total assets for the balance sheet, and total cash inflows for the cash flow statement.
• Vertical analysis is used in order to gain a picture of whether performance metrics are improving or deteriorating.
• As you can see there is a heavy focus on financial modeling, finance, Excel, business valuation, budgeting/forecasting, PowerPoint presentations, accounting and business strategy.
• Vertical analysis is also useful for trend analysis, to see relative changes in accounts over time, such as on a comparative basis over a five-year period.
• Remember to choose appropriate base figures, maintain consistency, and consider industry-specific factors to enhance the accuracy and relevance of your analysis.
• The interpretation shows us how to evaluate the performance of the business using the numbers and make comparison.

While horizontal analysis remains valuable for assessing changes over time, vertical analysis offers unique perspectives and granularity in financial analysis. Accurate and reliable financial statements are essential for conducting effective vertical analysis. If the financial statements contain errors or are not prepared in accordance with accounting principles, the results of vertical analysis may be misleading.

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. Vertical analysis is a valuable tool for investors who are looking to gain insight into a company’s performance over time. By comparing different items on the income and cash flow statements, you can get an idea of how the company manages its resources and identify potential opportunities or risks. In order to do a vertical analysis of a company’s cash flow statement, you will need to divide each item by the total net cash from operating activities.