Company Financial Statement Analysis & Interpretation Of Financial Statements

example of vertical analysis

Usually, the vertical analysis is done for a single period to see the proportionate account balances. But you can also it over several periods to identify changes in accounts over time.

We have no way of knowing, because we don’t know the cash positions of Companies A and B, how profitable Companies A and B are, etc. Double Entry Bookkeeping is here to provide you with free online information to help you learn and understand bookkeeping and introductory accounting. The best analysts understand this limitation and use tools like vertical analysis not to answer questions, but rather to figure out which questions need to be asked. As you can see, each account is referenced in proportion to the total revenue. A Vertical Analysis is performed for a specific period such as a month, quarter, year, etc. then it is compared to similar periods such as the first quarter of 2011, the first quarter of 2012, the first quarter of 2013, etc. A business that is incapable of paying off their debts on a timely basis is going to have a difficult time obtaining credit.

Step To Conduct Vertical Analysis Of A Balance Sheet

The key to analysis is to identify potential problems provide the necessary data to legitimize change. No company lives in a bubble, so it is also helpful to compare these results with those of competitors to determine whether the problem is industry-wide, or just within the company itself. If no problems exist industry-wide, one will observe a shortfall in Sales and rise in the dollar amount of Sales returns. Besides analyzing the past performance, analysis helps determine the strategy of a company moving forward. Most importantly, Financial Analysis points to the financial destination of the business in both the near future and to its long-term trends.

A business whose net earnings are less than most in the same industry may not only have a difficult time obtaining credit but also obtaining new capital from stockholders leading to a further decline in profitability. The Gross Profit of the Company grew in dollar terms, but the gross profit % dropped over the years. This shows that the cost of the raw materials and goods has increased and is not in line with the increase in sales. Business Checking Accounts BlueVine Business Checking The BlueVine Business Checking account is an innovative small business bank account that could be a great choice for today’s small businesses.

Calculate every other number down the income statement as a percent of sales. Repeat this process for the balance sheet information, by calculating each asset as a percent of total assets, and each liability as a percent of total liabilities. For this reason vertical analysis is also known as vertical common size analysis or simply common size analysis. A useful way to analyze these financial statements is by performing both a vertical analysis and a horizontal analysis. This type of analysis allows companies of varying sizes whose dollar amounts are vastly different to be compared.

How Vertical Analysis Works

Vertical analysis is the comparison of financial statements by representing each line item on the statement as a percentage of another line item. First, we should review the income statements as they’re presented in dollar terms. The company’s sales have grown over this time period, but net income is down sharply in year three. Salaries and marketing expenses have risen, which is logical, given the increased sales. However, these expenses don’t, at first glance, appear large enough to account for the decline in net income. Horizontal analysis is a common technique used to examine the changes in the line items of the income statement and the balance sheet from year to year. In accounting, a vertical analysis is used to show the relative sizes of the different accounts on a financial statement.

The financial statements prepared by using this technique are known as common size financial statements. For example, start by dividing net sales by net sales, giving you a result of one.

example of vertical analysis

Horizontal analysis allows investors and analysts to see what has been driving a company’s financial performance over several years and to spot trends and growth patterns. This type of analysis enables analysts to assess relative vertical analysis changes in different line items over time and project them into the future. For example, if the cost of sales has been consistently 45% in the history, then a sudden new percentage of 60% should catch the attention of analysts.

Horizontal allows you to detect growth patterns, cyclicality, etc. and to compare these factors among different companies. Keep in mind that more detail provides more opportunities to fine-tune your analysis and discover trends or outliers over time. Conversely, performing the analysis with a higher-level set of numbers makes it easier to quickly spot overall growth and spending trends for the company. The figures stated above we’re taken or consequent from the Balance Sheets of Jan 31st, 2009 and Jan 30th, 2010 and the 52-week periods Income Statement from those dates. The Total Assets from the company represent a figure of 21,300 in the latest year, which represent a decrease of 3. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries.

Vertical Analysis Formula

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When you identify significant differences, try to determine why the number is different. For example, if accounts receivable is higher than normal and cash is lower than normal, it could be that the company is having trouble collecting sales made on credit. When creating a Vertical Analysis of an Income Statement, the amounts of individual items are calculated as a percentage of Total Sales. Financial Statements often contain current data and the data of a previous period. This way, the reader of the financial statement can compare to see where there was change, either up or down. Without analysis, a business owner may make mistakes understanding the firm’s financial condition.

  • All of the amounts on the balance sheets and the income statements will be expressed as a percentage of the base year amounts.
  • For the balance sheet, the total assets of the company will show as 100%, with all the other accounts on both the assets and liabilities sides showing as a percentage of the total assets number.
  • If owner’s equity is $240,000 it will be shown as 60% ($240,000 divided by $400,000).
  • The difference in percentage is computed by taking the dollar difference in an Income Statement item and dividing it by the base year.
  • Under Horizontal Analysis , one shows the amounts of past financial statements as a percentage of amount from the base year.
  • Note that the line-items are a condensed Balance Sheet and that the amounts are shown as dollar amounts and as percentages and the first year is established as a baseline.

But, it can’t really answer “Why.” Like, in the above example we know cost is a major reason for the drop in the profits. But, we can’t be sure if the costs have actually risen, or the management has cut the prices of the product. This method looks at the financial performance over a horizon of many years.

How Is Horizontal Analysis Performed?

If the accounts payable are $88,000 they will be restated as 22% ($88,000 divided by $400,000). If owner’s equity is $240,000 it will be shown as 60% ($240,000 divided by $400,000). The vertical analysis of the balance sheet will result in a common-size balance retained earnings sheet. The percentages on a common-size balance sheet allow you to compare a small company’s balance sheets to that of a very large company’s balance sheet. A common-size balance sheet can also be compared to the average percentages for the industry.

You can find the balance sheets for public companies by searching the Securities and Exchange Commission database. Privately held companies often publish their financials in the investor relations section of their websites.

example of vertical analysis

The following example shows ABC Company’s income statement over a three-year period. Learn accounting fundamentals and how to read financial statements with CFI’s free online accounting classes. ledger account 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.

Vertical analysis, also called common-size analysis, focuses on the relative size of different line items so that you can easily compare the income statements and balance sheets of different sized companies. Compare prior periods of the same company’s data, in the common-size format, against your original data. Choose an account, and read across the years, looking for unusual growth or fluctuations. The above vertical financial statement analysis uses revenue as the base line item, however, other appropriate base line items such as total cash inflow could equally well have been used. Finally, vertical analysis can also be carried out on the cash flow statement. In the example below revenue has been chosen as the base line item and the right hand column shows each line item as a percentage of revenue which, for this example, is assumed to be 120,000. Vertical analysis can also be carried out on the balance sheet statement.

The vertical analysis of a balance sheet results in every balance sheet amount being restated as a percent of total assets. Vertical analysis expresses each amount on a financial statement as a percentage of another amount. To make the best use of your financial data, you need a robust toolkit with plenty of options for slicing and dicing information in meaningful ways. For example, in 2012, Current Assets are 36% of Total Assets for that year; whereas, in 2014, Current Assets are 56% of Total Assets. While you can still compare from one year to the next, the calculation to determine the percentage is within the same period i.e. down the column . Such an analysis also helps in understanding the percentage/share of the individual items, and the structural composition of components, such as assets, liabilities, cost, and expenses.

It also shows how a vertical analysis can be very effective in understanding key trends over time. The same process applied to ABC Company’s balance sheet would likely reveal further insights into how the company is structured and how that structure is changing over time. Vertical analysis is said to get its name from the up and down motion of your eyes as you scan the common-size financial statements during the analysis process.

This means the company needs to reduce its cost of goods sold while trying to increase or maintain its total sales amount to increase its gross and net profits in year three. Account analysis is a process in which detailed line items in a financial transaction or statement are carefully examined for a given account. An account analysis can help identify trends or give an indication of how an account is performing.

After squaring the differences and adding them up, then dividing by the total number of items, we find that the variance is 56,334. Taking the square root of that, we get the standard deviation, which is $7,506. This method is particularly useful for both internal analysis to identify areas of growth and external analysis by investors or lenders who want to see demonstrable growth before committing their resources to your business. Today’s economy is undergoing constant and significant change thanks to digital disruption, complex globe-spanning phenomena like climate change and the COVID-19 pandemic, and the ever-expanding impact of Big Data. To compete effectively and strategically, it’s important for businesses of all sizes to make use of the tools at their disposal.

So, for example, when analyzing an income statement, the first line item, sales, will be established as the base value (100%), and all other account balances below it will be expressed as a percentage of that number. Like horizontal analysis, vertical analysis is used to mine useful insights from your financial statements. It can be applied to the same documents, but is exclusively percentile-based and travels vertically within each period across periods, rather than horizontally across periods. There’s a wealth of data lurking inside your company’s financial statements—and if you know how to analyze it effectively, you can transform financial information into actionable insights.

Author: Mark Kennedy