acctg211 Vertical Analysis

From the balance sheet’s horizontal analysis you may see that inventory and accounts payable have been growing as a percentage of total assets. Vertical analysis is used to show the relative size of each item line of the income statement and the balance sheet. The total revenue is taken as a base item, and other heads of the income statement are presented as a percentage of the base figure. Vertical analysis is used to analyze the different accounts of the financial statements and describe the changes in the relative size of each item. It is a management tool used by companies in analyzing the changes in the relative size of different accounts over several years. It is also helpful in comparing the financial statements of two companies with the industry average.

• This calculation helps identify trends and fluctuations in financial performance, which is useful in making informed business decisions.
• The total revenue is taken as a base item, and other heads of the income statement are presented as a percentage of the base figure.
• 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.
• It also shows how a vertical analysis can be very effective in understanding key trends over time.
• The process is virtually identical to our common size income statement, however, the base figure is “Total Assets” as opposed to “Revenue”.
• Performing vertical analysis creates the so-called “common size” income statement and the “common size” balance sheet.

The vertical analysis also shows that in years one and two, the company’s product cost 30% and 29% of sales, respectively, to produce. First, we can see that the company’s marketing expenses increased not just in dollar terms, but also as a percentage of sales. This implies that the new money invested in marketing was not as effective in driving sales growth as in prior years. The following example shows ABC Company’s income statement over a three-year period. Most accounting computer programs, including QuickBooks, Peachtree, and MAS 90, provide common-size analysis reports. You simply select the appropriate report format and financial statement date, and the system prints the report.

Common Size Analysis of Financial Statements

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.

• If interest expense is $50,000 it will be presented as 5% ($50,000 divided by $1,000,000).
• It expresses each item as a percentage of a base figure, usually total assets or total liabilities.
• For instance, if a most recent year amount was three times as large as the base year, the most recent year will be presented as 300.
• To reiterate from earlier, dividing by total assets is akin to dividing by the sum of liabilities and equity.
• This helps to make it easier to spot trends in financial performance, such as increased or decreased activity within a particular area.
• For example, if the cost of goods sold has a history of being 40% of sales in each of the past four years, then a new percentage of 48% would be a cause for alarm.

Where horizontal analysis looked at one account at a time, vertical analysis will look at one YEAR at a time. To conduct a vertical analysis of balance sheet, the total of assets and the total of liabilities and stockholders’ equity are generally used as base figures. All individual assets (or groups of assets if condensed form balance sheet is used) are shown as a percentage of total assets.

Step 4: What item is used as the base for the balance sheet?

This type of analysis is used to compare financial statements from different periods, or to compare different companies’ statements. It is a useful tool for investors, analysts, and financial professionals in order to measure the performance of a company. Performing vertical analysis is relatively straightforward, but it does require some basic knowledge of financial statements. First, you need to determine the base figure that you will use for your analysis. This is typically either total assets or total liabilities for balance sheets, and total sales for income statements. Vertical analysis is a form of financial statement analysis that assesses the relative size of different line items on a balance sheet, income statement, or statement of cash flows to one another.

Vertical analysis refers to the comparative analysis of the financial statement in which each line item is represented as a percentage of the base item. The items on the income statement are presented as a percentage of total revenue, and the items on the balance sheet are presented https://turbo-tax.org/sales-tax-and-income-tax/ as a percentage of total assets or total liabilities. The vertical analysis of the cash flow statement is made by showing each cash outflow and inflow as a percentage of the total cash inflows. To illustrate horizontal analysis, let’s assume that a base year is five years earlier.

Vertical vs. Horizontal Analysis

ABC Company’s income statement and vertical analysis demonstrate the value of using common-sized financial statements to better understand the composition of a financial statement. It also shows how a vertical analysis can be very effective in understanding key trends over time. To do that, we’ll create a “common size income statement” and perform a vertical analysis. For each account on the income statement, we divide the given number by the company’s sales for that year. Notice that PepsiCo has the highest net sales at $57,838,000,000 versus Coca-Cola at $35,119,000,000. Once converted to common-size percentages, however, we see that Coca-Cola outperforms PepsiCo in virtually every income statement category.

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. In accounting, a vertical analysis is used to show the relative sizes of the different accounts on a financial statement. In general, managers prefer expenses as a percent of net sales to decrease over time, and profit figures as a percent of net sales to increase over time. As you can see in Figure 13.5 “Common-Size Income Statement Analysis for “, Coca-Cola’s gross margin as a percent of net sales decreased from 2009 to 2010 (64.2 percent versus 63.9 percent). Income before taxes increased significantly from 28.6 percent in 2009 to 40.4 percent in 2010, again mainly due to a one-time gain of $4,978,000,000 in 2010. This caused net income to increase as well, from 22.0 percent in 2009 to 33.6 percent in 2010.

3 Common-Size Financial Statements

Here, we’ve chosen “Revenue” as the base figure for the common size income statement, followed by “Total Assets” for the common size balance sheet. Vertical analysis makes it much easier to compare the financial statements of one company with another, and across industries. Vertical analysis (also known as common-size analysis) is a popular method of financial statement analysis that shows each item on a statement as a percentage of a base figure within the statement. Since we use net sales as the base on the income statement, it tells us how every dollar of net sales is spent by the company.