vertical analysis formula

House Authors

2 min read

·

14-10-2024

67

0

Share

Unveiling Your Business's Health: A Deep Dive into Vertical Analysis

Understanding your business's financial performance is crucial for making informed decisions. While financial statements provide a snapshot of your company's health, vertical analysis offers a powerful lens to analyze individual line items in relation to the whole. This analysis helps you understand the composition of your business, identify trends, and make comparisons across different periods.

What is Vertical Analysis?

Vertical analysis, also known as common-size analysis, is a financial statement analysis technique that expresses each line item as a percentage of a base figure within the same statement. This allows you to compare the relative size of different components within a single period, fostering a deeper understanding of your financial structure.

The Formula for Vertical Analysis

The formula for vertical analysis is simple:

Percentage = (Individual Line Item / Base Figure) * 100

The base figure varies depending on the financial statement you're analyzing:

• Income Statement: Base figure is typically total revenue or net sales.
• Balance Sheet: Base figure is usually total assets or total liabilities and equity.

Practical Examples

Let's illustrate with some real-world examples:

Example 1: Income Statement

Imagine a company with $100,000 in revenue and $20,000 in cost of goods sold. Applying the vertical analysis formula, we get:

• Cost of goods sold percentage = ($20,000 / $100,000) * 100 = 20%

This means that 20% of the company's revenue is spent on producing the goods it sells.

Example 2: Balance Sheet

A company has $500,000 in total assets and $200,000 in current assets.

• Current assets percentage = ($200,000 / $500,000) * 100 = 40%

This shows that 40% of the company's total assets are in liquid form, readily available for short-term obligations.

Benefits of Vertical Analysis

• Enhanced Trend Analysis: By comparing percentages across different periods, you can identify trends in specific areas of your business, like increasing or decreasing cost of goods sold as a percentage of sales.
• Improved Benchmarking: Compare your company's vertical analysis results to industry averages or competitors to assess your performance relative to others.
• Identification of Potential Issues: Abnormal percentages can signal areas needing closer attention, for example, a significantly higher percentage of accounts receivables might indicate issues with collections.
• Simplified Comparisons: Vertical analysis facilitates easy comparison across different periods or different companies with varying sizes, eliminating the impact of absolute dollar amounts.

Key Takeaways

Vertical analysis is a valuable tool for business owners, managers, and investors. It provides a deeper understanding of your business's financial structure and helps you identify key trends and areas needing improvement. By employing vertical analysis, you can make informed decisions to optimize your financial performance and drive your business toward success.