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Vertical Analysis

The proportional analysis of financial data

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.

 

Vertical Analysis

 

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.

 

Practical Examples

 

1. Comparative Balance Sheet with Vertical Analysis

 

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

 

Comparative Income Statement with Vertical Analysis

 

*2018: ($104,000 / $198,000) × 100 = 52.53%
**2017: ($98,000 / $176,000) × 100 = 55.68%

 

Related Readings

CFI offers the Certified Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

  • Analysis of Financial Statements
  • Projecting Balance Sheet Line Items
  • Top-Down Budgeting
  • Vertical Equity

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