Vertical Financial Analysis

Vertical Financial 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 Financial Analysis? 

Vertical financial analysis is important for evaluating a company’s financial standing. In a Vertical Financial Analysis , 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 Financial 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 Financial Analysis works 

Comparing financial accounts between companies and across industries is made considerably simpler by Vertical Financial Analysis . This is because account balance ratios are visible. Additionally, 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 Financial Analysis used? 

The most typical use of Vertical Financial 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 Financial 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 Financial Analysis

Men’s, women’s, and kids’ clothes are all produced by the ABC Company. The shop manager is utilising the Vertical Financial 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 Financial 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. 

 

Frequently Asked Questions

Vertical Financial Analysis involves analysing the income statement or balance sheet by comparing line items as a percentage of a base amount, usually total revenue or assets. This type of analysis helps identify trends and changes in the company’s financial health over time.  

Horizontal analysis, on the other hand, compares financial data over a specific period, usually a year, showing the absolute and percentage change in line items. This analysis helps in understanding the growth or decline in specific line items and their impact on the company’s overall financial performance.  

While both vertical and horizontal analyses are essential for gaining insights into a company’s financial performance, they focus on different aspects. They can be used together for a more comprehensive financial analysis. 

One of the primary advantages of vertical financial analysis is that it allows for a detailed and comprehensive understanding of a company’s financial health. By examining trends in key financial indicators, such as revenue, gross margin, operating expenses, and net income, businesses can identify areas of strength and weakness and make informed decisions about allocating resources and prioritising investments. 

Another advantage of vertical financial analysis is that it can help businesses identify potential problems before they become major. By monitoring changes in key ratios, such as debt-to-equity or current ratio, businesses can identify trends that may indicate financial distress or instability. This allows them to take corrective action, such as reducing debt or improving cash flow before the situation becomes critical. 

The Vertical Financial Analysis formula is VA = Item / Base amount (100). The object you are examining is called the item, and the base amount is the whole amount. 

Although it offers several advantages, there are also some disadvantages that businesses need to be aware of.  

  • It does not assist a business in measuring liquidity. 
  • Due to the varying ratios of the items, it does not offer a high-quality examination of the financial statements. 
  • Additionally, the vertical financial analysis does not consider industry or economic trends affecting the company’s financial performance.  
  • It also does not provide any insight into the company’s competitors, making it difficult for businesses to compare their financial performance with others in their industry.  
  • It doesn’t adhere to accounting principles and practices. 

Vertical Financial Analysis of the balance sheet is a financial analysis technique that involves the evaluation of the balance sheet of a company in terms of the percentage of each item to the total assets or liabilities. It involves breaking down the balance sheet into its components, such as assets, liabilities, and equity, and expressing each component as a percentage of the total assets. This allows analysts to better understand the proportion of each item on the balance sheet and how it relates to the company’s overall financial health.  

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