What is Vertical Analysis?
Vertical analysis is an accounting tool that enables the performance of proportional analysis of documents, such as financial statements. While performing a vertical analysis, every line item on the financial statement is entered as a percentage of another item. Thus, in an income statement, every line item is stated in terms of the percentage of gross sales.
Similarly, in a balance sheet, every entry is made not in terms of absolute currency but as a percentage of the total assets. Performing a vertical analysis of a company’s cash flow statement represents every cash outflow or inflow relative to the total cash inflows of the company.
When is Vertical Analysis Used?
Vertical analysis is most commonly used within a financial statement for a single reporting period, e.g., quarterly. It is done so that accountants can ascertain the relative proportions of the balances of each account. Vertical analysis is exceptionally useful while charting a regression analysis or a ratio trend analysis. It enables the accountant to see relative changes in company accounts over a given period of time. The analysis is especially convenient to do so on a comparative basis.
Advantages of Vertical Analysis
- Vertical analysis simplifies the correlation between single items on a balance sheet and the bottom line, as they are expressed in a percentage. The percentages can be used by a company’s management to set goals and threshold limits. For example, management may consider shutting down a particular unit if profit per unit falls below a particular threshold percentage.
- It is a relatively more potent tool than horizontal analysis, which shows the corresponding changes in the finances of a particular unit/ account/department over a certain period of time.
- It is also useful in comparing a company’s financial statement to the average trends in the industry. It would be ineffective to use actual dollar amounts while analyzing entire industries. Common-sized percentages solve such a problem and facilitate industry comparison.
- It is also highly effective while comparing two or more companies operating in the same industry but with different sizes. It is often tricky to compare the balance sheet of a $1 billion company to one that is valued at $500,000. Vertical analysis enables accountants to create common-sized accounts, which enable them to compare and contrast amounts of different magnitudes in a very efficient manner.
1. Comparative Balance Sheet with Vertical Analysis
*2019: ($50,000 / $64,000) × 100 = 78.13%
**2018: ($43,000 / $56,100) × 100 = 76.65%
2. Comparative Income Statement with Vertical Analysis
*2018: ($104,000 / $198,000) × 100 = 52.53%
**2017: ($98,000 / $176,000) × 100 = 55.68%
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