What Does Vertical Analysis Mean?
Vertical analysis is the analysis of a financial statement wherein each item on a particular statement is represented as a percentage of the base figure. In such analyses, the relationship between items in the same financial statement is identified by expressing all amounts as a percentage of the total amount.
Divestopedia Explains Vertical Analysis
Vertical analysis provides the relative annual changes within an organization while horizontal analysis focuses on the fluctuation of a specific figure during a set time frame. Generally, the total of assets, total of liabilities and stockholders' equity are employed as base figures with regards to a balance sheet. The individual assets are shown as a percentage of total assets. The current liabilities, long-term debts and equity are shown in terms of a percentage of total liabilities and stockholders’ equity.
For example, if there are three categories of assets such as $3,000 cash, $8,000 of inventory and $9,000 in property, then they will appear in the asset column as 15% cash, 40% inventory and 45% property.
For the vertical analysis of an income statement, sales figures are used as the base figure and all other components, such as the cost of sales, gross profit, operating expenses, net income, etc., are shown as a percentage of sales. This method compares different items to a single item in the same accounting period.
Advantages of using vertical analysis:
- It gives financial statements in a comparable percentage form.
- A basic vertical analysis needs one individual statement for one reporting period. Comparative statements may be prepared to increase the usefulness of the analysis.
- Firms of different sizes can be compared easily as all the items are expressed as a percentage. Comparison of financial performance and position of firms of different sizes is not very useful when absolute figures are considered.
- Vertical analysis is also useful in comparing an individual firm’s performance over a number of periods as it helps to identify unusual changes in the behavior of a particular account. For example, if cost of sales is consistently 45%, but jumps to 60% for a particular period, then the reasons need to be identified and corrective measures be taken accordingly.
In a confidential information memorandum, vertical analysis will help prospective buyers assess the variability of expenses and prepare their own forecasts to determine an appropriate purchase price.