Vertical Analysis Common-size Financial Statement Pros & Cons

Vertical Analysis Common-size Financial Statement Pros & Cons

You know how to do a vertical analysis with Excel and Google Sheets, using both an income statement and a balance sheet. One of the pros of vertical analysis is that it allows for the comparison of financial statements from one accounting period to the next as well as for comparisons among different companies. One of its cons is that it doesn’t take into consideration absolute numbers; so if you are comparing two companies, looking at percentages will give a different result than absolute numbers. 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. The business will need to determine which line item they are comparing all items to within that statement and then calculate the percentage makeup.

Step 3. Vertical Analysis of Balance Sheet

• Though a useful tool on its own, vertical analysis can be a more useful tool when used in conjunction with horizontal analysis.
• Including a long-term debt or equity as a proportion of total assets ratio on the income accounts is one possible way to do this.
• When used together, they offer a comprehensive view of the company’s financial health.
• In this example, we calculated each line item’s percentage relative to net sales.
• This could be a normal consequence of a more mature business unit, but highlights a trend worth considering.
• The common size Fraction is also useful for comparing businesses that operate in the same industry but use different currencies or those that operate in a completely different industry.

Each item in the income statement is divided by the company’s total sales for that year (which gives us a common size income statement). Vertical analysis applied to the balance sheet complements the insights gained from the income statement. This dual approach offers a comprehensive view, enabling a more informed financial strategy that covers both earnings performance and asset management. You can analyze multiple periods separately, then do a horizontal analysis to look for trends. If you already use templates for your financial statements, it’s easy to include the formulas for vertical analysis by adding columns or a new section.

Integrating vertical analysis into financial reporting and communication

We can see that current assets make up 40% of total assets, which could indicate that the company is keeping a relatively large amount of cash on hand. This may or may not be a red flag, depending on the company’s industry and growth strategy. Using this proportional analysis, you can better control total cash inflows and manage budget costs. You can pick out expenses with bigger percentages and work on how you can reduce them.

Use of Common-Size Financial Statements

• Just like any financial statement analysis method, vertical analysis isn’t a one-time task.
• In the above table, we see that COGS (Cost of Goods Sold) for the company spiked in year three.
• With Acterys, FP&A professionals can conduct thorough vertical analysis and make well-informed decisions thanks to its scenario planning and collaboration features.
• This could prompt management to reevaluate their marketing strategy or cost structure to enhance profitability.

Vertical analysis can account for businesses of different sizes or those with multiple departments and product lines, making cohort analysis and the process of comparing profitability much easier. We’ll not only cover the basics but also guide you through its practical application in analyzing income statements. Plus, we’ll explore its strategic significance for FP&A, demonstrating how it can be a valuable asset in financial planning and analysis. Both vertical and horizontal analysis methods provide valuable information/insights. When used together, they offer a comprehensive view of the company’s financial health. Vertical analysis provides a better understanding of how each line item on the balance sheet fits into the company’s financial structure and is an invaluable decision-making tool.

Utilizing tools in conjunction with vertical common size analysis significantly helps with financial reporting. It enables businesses to gain quick insights into historical performance by comparing current values to previous periods. You can then get a summary of how the business is operating and performing https://www.bookstime.com/ over time. The key benefit of vertical financial statement analysis is that it allows you to compare income statements and balance sheets from organizations of various sizes. As noted before, we can see that salaries increased to 22% as a percentage of total sales in Year 3, compared to 20% in year 2.

Step 2: Identify total assets

To demonstrate its real-life applications, here are some examples of vertical analysis and how you can utilize them in curating a high-performing business model. Here, we’ll look at the steps you need to take to complete a vertical analysis for your business. Here at Business2Community, we’re committed to sharing the most how to calculate vertical analysis useful techniques for your business development. In this article, we’ll walk you through everything you need to know about vertical analysis and how to perform one. The shareholder’s funds, as seen in the common-size balance sheet, are 53.33% of the total funds for Y Ltd., whereas, in the case of X Ltd. is 50% only.

• We’ve now completed our vertical analysis for our company’s income statement and will move on to the balance sheet.
• This approach is vital for planning and guiding a company’s financial future in a straightforward way.
• Example of the vertical analysis accounting of the financial statement, which shows the total amount and percentage.
• The business will need to determine which line item they are comparing all items to within that statement and then calculate the percentage makeup.
• Likewise, all the items in the balance sheet are stated as a percentage of the total assets.

Balance sheet vertical analysis uses total assets as a base and assigns a percentage to all line items. Today, I want to talk about vertical analysis, a method of financial statement analysis that I’ve found incredibly useful in my career. If you’re not familiar with it yet, don’t worry – I’m here to break it down for you in a way that’s easy to understand. Income statement analysis can help you analyze the distribution of costs and expenses relative to revenue. This helps in evaluating the efficiency of cost management which thus identifies areas of improvement.

• They can then use this information to make business decisions such as preparing the budget, cutting costs, increasing revenues, or investments in property plant or equipment.
• When comparing different financial accounts, vertical analysis is a useful tool and a well-known strategy to use.
• When you apply vertical analysis to the balance sheet, you can understand the relative composition of assets, liabilities, and equity.
• Over three years, you might notice salaries increasing from 31% to 42% of revenue.
• You simply receive a concise view of your line items without performing complex calculations.
• Vertical common size analysis provides a valuable tool for FP&A professionals to gain insights into the composition, trends, and relationships within a company’s financial statements.