Vertical analysis

Vertical analysis

Vertical financial analysis is a powerful tool for evaluating a company’s financial performance. By presenting financial statements in a vertical format, it enables companies to identify trends, assess their financial structure, and compare their performance with others in the industry. It is an essential tool for investors, financial analysts, and business owners to make informed decisions regarding investment opportunities or future growth strategies. 

What is vertical analysis? 

Vertical financial analysis is important for evaluating a company’s financial standing. In this method, a company’s financial statements are analysed in a vertical format. Each item in the statement is presented as a percentage of the total revenue or assets. This analysis aims to identify the trends in a company’s financial performance, understand the company’s financial structure, and assess its overall health. 

Understanding vertical analysis 

Vertical financial analysis is commonly used to evaluate a company’s income statement and balance sheet. In an income statement, the analysis presents each item as a percentage of revenue, while in a balance sheet, each item is presented as a percentage of total assets.  

For example, an income statement presents the cost of goods sold, research and development expenses, and operating expenses as a percentage of revenue. This helps to determine the business’s cost structure and identify potential areas for improvement. 

Similarly, in a balance sheet, the analysis presents each item as a percentage of total assets. For instance, the percentage of current assets to total assets or the percentage of long-term liabilities to total liabilities can provide insights into the company’s liquidity and solvency.  

Vertical financial analysis can also be used to compare the financial performance of different companies in the same industry. By presenting financial information in a uniform format, it is easier to compare the financial performance of different companies. This can help identify the strengths and weaknesses of each company and enable investors to make informed decisions. 

How vertical analysis works 

Comparing financial accounts between companies and across industries is made considerably simpler by vertical analysis. This is because account balance ratios are visible. Also, it facilitates the comparison of the previous period for time series analysis, which compares quarterly and yearly numbers over the years to see if performance indicators are increasing or declining. 

One way to examine how they affect profit margins and whether profitability increases over time is to display the numerous expenditure line items in the income statement as a proportion of sales. Hence, comparing a company’s profitability to its competitors is simpler. 

When is vertical analysis used? 

The most typical use of vertical analysis in a financial statement is for a particular reporting period, such as a quarterly one. It is done this way so accountants can determine the balanced proportions of each account’s balances. 

Vertical analysis is incredibly beneficial when plotting a ratio trend analysis or a regression analysis. It allows the accountant to gauge how the business’s financial statements have changed over time. Analysing on a comparative basis is extremely practical. 

Example of vertical analysis 

Men’s, women’s, and kids’ clothes are all produced by the ABC Company. The shop manager is utilising the vertical analysis to determine what percentage of sales are made up of children’s clothes at the retail site, which recently celebrated one year in operation

A total of 20,000 products were sold by the business, of which 2,500 were clothes for women. 

Sales in year one: 20,000 

Clothing for women: 2,500 

Vertical analysis: VA = 2,500 / 20,000 (100) = 12.5% of sales are made up of women’s clothes. 

The manager calculates that women’s clothes made around 12.5% of the total sales. 

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