With our financial data presented in Excel, we can start to calculate the contribution percentages on either the side or below the income statement. The standard base figures for the income statement and balance sheet are as follows. Conceptually, vertical analysis can be thought of as reading a single column of financial data and determining the relationships among each item to reflect the relative size of the various cost and profit metrics. In the above vertical analysis example, we can see that the income decreases from 1st year to 2nd year, and the income increases to 18% in the 3rd year. So by using this method, it is easy to understand the net profit as it is easy to compare between the years.

1. First, gather the balance sheet figures for each line item, such as cash, accounts receivable, fixed assets, etc.
2. By applying vertical analysis to your financial statements, you can gain valuable insights into the composition and distribution of your company’s assets, liabilities, and income.
3. Both vertical and horizontal analysis methods provide valuable information/insights.
4. In accounting, a vertical analysis is used to show the relative sizes of the different accounts on a financial statement.
5. Once we divide each balance sheet item by the “Total Assets” of $500 million, we are left with the following table.
6. 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.

So if we had multiple years of historical data, it is recommended to organize the percentage calculations into a single section on the far right or below the financials with the timing of the periods aligned. Starting from the revenue line item, each line item on the income statement – if deemed appropriate – is divided by revenue (or the applicable core metric). Learn the definition of vertical analysis in finance, how it works, and get a clear example to understand this concept better. Despite the benefits and insights that vertical analysis can provide, it’s essential to acknowledge its limitations and drawbacks. Returning to our example above, a vertical analysis of Jackson Widget Company’s balance sheet would look like this. Look for items with a significant percentage of Total Assets, as these could represent areas of vulnerability or strength.

Step 3. Vertical Analysis of Balance Sheet

We can easily understand that the total expenses gradually increased from 43% to 52%, and the net income get reduced from 1st year to 2nd year. In the 3rd year, the COGS decreased compared to the previous years, and the income increased. Vertical analysis is exceptionally useful while charting a regression analysis or a ratio trend analysis.

Vertical Analysis of the Income Statement

This approach provides insights into patterns over time, highlighting increases, decreases, or trends. For example, it can help identify if a company’s accounts receivable has steadily increased over the past three years, which could indicate a problem with credit and collection policies. That’s $100,000 in cash plus $40,000 in accounts receivable plus $50,000 of fixed assets. 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.

How to Perform a Vertical Analysis on Your Balance Sheet

In our case, half of the company’s asset base comprises PP&E, with the rest coming from its current assets. Once we divide each balance sheet item by the “Total Assets” of $500 million, we are left with the following table. The placement is not much of a concern in our simple exercise, however, the analysis can become rather “crowded” given numerous periods.

If you want to take your variance analysis to the next level, check out FloQast Variance Analysis. It offers a better way to perform flux and budget variance analysis by automating the data collection process and integrating with your ERP. For each line item on the balance sheet, divide it by the Total Assets and multiply the result by 100.

Vertical Analysis is a form of financial analysis where the line items on a company’s income statement or balance sheet is expressed as a percentage of a base figure. For example, by showing the various expense line items in the income statement as a percentage of sales, what is unearned revenue a definition and examples for small businesses one can see how these are contributing to profit margins and whether profitability is improving over time. Vertical analysis of a balance sheet can be a powerful tool to understand your company’s performance or how two businesses compare. Try it with your next financial analysis and see if it provides useful insights or helps you track progress toward goals. Do you want to take your financial analysis skills to the next level and get more detailed insight into your financial statements? Learning how to perform a vertical balance sheet analysis can equip you with the skills to extract actionable insights into your company’s current financial health.

Step 5: Compare with industry benchmarks

In contrast, the process is practically the same for the balance sheet, but there is the added option of using “Total Liabilities” instead of “Total Assets”. But we’ll utilize the latter here, as that tends to be the more prevalent approach taken. We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. Further, when working with large data sets, we recommend cleaning up the data to improve the overall visual representation of the analysis. Regardless of the placement, the more important factor is to ensure the analysis clearly shows which period it is reflecting. Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs.

Both vertical and horizontal analysis methods provide valuable information/insights. When used together, they offer a comprehensive view of the company’s financial health. For example, when a vertical analysis is done on an income statement, it will show the top-line sales number as 100%, and every other account will show as a percentage of the total sales number. 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. Both techniques provide valuable insights for financial analysis and decision-making, but they serve different purposes and offer distinct perspectives on a company’s financial performance.

The common-sized accounts of vertical analysis make fair value vs fair market value it possible to compare and contrast numbers of far different magnitudes in a meaningful way. This change could be driven by higher expenses in the production process, or it could represent lower prices. We can’t know for sure without hearing from the company’s management, but with this vertical analysis we can clearly and quickly see that ABC Company’s cost of goods sold and gross profits are a big issue. The vertical analysis also shows that in years one and two, the company’s product cost 30% and 29% of sales, respectively, to produce.

Let’s look at an example to see how applying the vertical analysis formula might work in the real world. Once the historical data from 2021 has been inputted into Excel, we must determine the base figure to use. Let us understand the advantages of vertical analysis equation through the points below. Horizontal analysis indicates long-term trends and highlights areas of strength and those that need improvement. Vertical analysis indicates the relative importance of each line item in a certain period. Compare your results with industry benchmarks or similar companies to see how your business stacks up.

However, these expenses don’t, at first glance, appear large enough to account for the decline in net income. 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. For instance, we can see that our company’s long-term debt as a percentage of total assets is 17.0%.

Common-size financial statements often incorporate comparative financial statements that include columns comparing each line item to a previously reported period. Another powerful application of a vertical analysis is to compare two or more companies of different sizes. It can be hard to compare the balance sheet of a $1 billion company with that of a $100 billion company.

First, gather the balance sheet figures for each line item, such as cash, accounts receivable, fixed assets, etc. You can likely export the company’s financial statements from your accounting software to an Excel spreadsheet for easy analysis. Likewise, all the items in the balance sheet are stated as a percentage of the total assets. The opposite of the vertical analysis of financial statements is the Horizontal analysis always looks at the amount from the financial statement over the horizon of many years. The significance of vertical analysis accounting is well-established in businesses irrespective of their size or stature. Vertical analysis is an accounting tool that enables proportional analysis of documents, such as financial statements.