Vertical Analysis

Vertical Analysis

What is vertical analysis?

Vertical analysis expresses each line item in a financial statement as a percentage of a chosen base figure for the same reporting period. Common bases:
– Income statement: net (or gross) sales/revenue = 100%
– Balance sheet: total assets (or total liabilities + equity) = 100%
– Cash flow statement: total cash inflows or total cash outflows = 100%

Also called common-size analysis, vertical analysis reveals the relative importance of each item within a single period.

How it works

• Choose the financial statement and the base figure (e.g., sales for the income statement).
• Divide each line item by the base figure and multiply by 100 to get a percentage.
• Present the results in a separate column (the common-size column) alongside dollar amounts.

Formula:
– Line item percentage = (Line item amount / Base figure) × 100%

Uses:
– Compare the composition of financial statements across companies and industries.
– Assess the internal structure of a company’s finances (profit margin drivers, cost structure).
– Track whether components (e.g., expenses as a percentage of sales) are improving or worsening over time.

Common-size financial statements

When companies prepare financial statements with vertical analysis, each statement becomes a common-size financial statement. These often include comparative columns for prior periods, facilitating cross-sectional and limited trend comparisons within the same period base.

Example

Assume XYZ Corporation (one period):
– Gross sales: $5,000,000 (base = 100%)
– Cost of goods sold: $1,000,000 → 20% of sales
– General & administrative expenses: $2,000,000 → 40% of sales
– Pre-tax income: $2,000,000 → 40% of sales
– Tax (25% of pre-tax income): $500,000 → 10% of sales
– Net income: $1,500,000 → 30% of sales

This common-size presentation makes it easy to see margins and expense drivers at a glance.

Simple nonfinancial example:
– Total units sold: 40,000
– Sneakers: 14,000 → 35%
– Boxing gloves: 26,000 → 65%

Vertical vs. horizontal analysis

• Vertical analysis: expresses items within one period as percentages of a base figure to show relative structure.
• Horizontal (trend) analysis: compares the same line items across multiple periods, showing percentage change over time relative to a base year.

Both are complementary: vertical analysis clarifies composition within a period; horizontal analysis reveals trends over time.

Pros and cons

Pros:
– Improves comparability across companies and industries regardless of size.
– Highlights which items drive margins and financial structure.
– Easy to interpret and communicate.

Cons:
– Ignores absolute dollar scale (a high percentage may reflect low absolute amounts).
– Can hide issues that only appear when looking at raw numbers or longer-term trends.
– Requires consistent accounting policies for meaningful cross-company comparisons.

Key takeaways

• Vertical analysis converts financial statement line items into percentages of a base figure, creating common-size statements.
• It helps compare structure and profitability across companies, within a company, and across industries in a single period.
• Use vertical analysis together with horizontal and ratio analysis for a fuller view of financial performance and trends.