How to Perform a Vertical Analysis on Financial Statements
Uncover the relative proportions within your financial statements with vertical analysis for deeper insights into business performance.
Vertical analysis is a financial statement analysis technique that expresses each line item on a financial statement as a percentage of a base figure from the same statement. This method helps users understand the proportional relationships and composition of a company’s financial performance and position. By converting dollar amounts into percentages, vertical analysis simplifies the assessment of how different components contribute to the overall financial picture, providing a clearer view of their relative significance.
Key Financial Statements for Analysis
Vertical analysis is commonly applied to two primary financial statements: the Income Statement and the Balance Sheet. Each statement provides distinct insights into a company’s operations and financial health when subjected to this proportional analysis. These statements offer fundamental data necessary for understanding a business’s financial structure.
The Income Statement, which summarizes revenues and expenses over a period, typically uses “Total Revenue” or “Net Sales” as its base figure for vertical analysis. All other line items, such as Cost of Goods Sold, Operating Expenses, and Net Income, are then expressed as a percentage of this total revenue. This approach reveals the proportion of each revenue and expense component, providing a clear picture of how sales translate into profit.
The Balance Sheet, which presents a company’s assets, liabilities, and equity at a specific point in time, uses “Total Assets” as its base figure. Every asset, liability, and equity item is then expressed as a percentage of this total. This allows for an understanding of the composition of a company’s assets, how those assets are financed through liabilities, and the proportion attributable to owner’s equity.
Performing Vertical Analysis on the Income Statement
Performing vertical analysis on the Income Statement involves converting each financial figure into a percentage of total revenue. The “Total Revenue” or “Net Sales” figure serves as the 100% base for all calculations, representing the entirety of the company’s sales during the reporting period.
The formula for calculating the vertical analysis percentage for any line item on the Income Statement is: (Line Item Amount / Total Revenue) x 100%. For instance, if a company has $500,000 in Total Revenue and $200,000 in Cost of Goods Sold, the vertical analysis percentage for Cost of Goods Sold would be ($200,000 / $500,000) x 100% = 40%. Similarly, if Operating Expenses are $150,000, their percentage would be ($150,000 / $500,000) x 100% = 30%. This calculation is applied to every line item, including Gross Profit, Operating Income, and Net Income, to show their relative contribution to or consumption of revenue.
Performing Vertical Analysis on the Balance Sheet
Applying vertical analysis to the Balance Sheet provides a proportional view of a company’s financial position. “Total Assets” serves as the 100% base figure for all percentage calculations, representing 100% of the company’s resources.
The formula used to calculate the vertical analysis percentage for any Balance Sheet line item is: (Line Item Amount / Total Assets) x 100%. For example, if Total Assets are $1,000,000, and Current Assets are $400,000, their percentage would be ($400,000 / $1,000,000) x 100% = 40%. If Current Liabilities are $250,000, their percentage would be ($250,000 / $1,000,000) x 100% = 25%. This calculation is performed for all asset, liability, and equity accounts, where the sum of all asset percentages equals 100%, and the sum of all liability and equity percentages also equals 100%, reflecting the fundamental accounting equation (Assets = Liabilities + Equity).
Interpreting the Analysis Results
Interpreting vertical analysis percentages offers significant insights into a company’s financial structure and performance. These percentages reveal the relative weight and composition of each element within the financial statements. For instance, an income statement shows what percentage of revenue is consumed by expenses and what remains as net income. Comparing percentages across reporting periods helps identify trends, such as declining efficiency if operating expenses rise relative to revenue. These common-size percentages can also be benchmarked against industry averages or competitors, providing context on efficiency, asset utilization, or financial strength, and informing strategic decisions.