This involves staying up to date with industry trends and evolving financial practices, as well as evaluating the outcomes of decisions influenced by this analysis. 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. Vertical analysis can guide decision-making processes by providing insights into the financial implications of various options. Whether you’re considering cost-cutting measures, pricing strategies, or investment decisions, vertical analysis helps evaluate the potential impact on key line items.

Vertical Analysis of Income Statement

• If you were to compare the two different years using the vertical analysis percentage, you can see what changes have been made and whether or not they were beneficial for the business.
• This method proves more insightful than relying solely on generic financial ratios or industry benchmarks.
• This percentage method is most useful when identifying changes over a longer period of time where there may be significant deviations from the base period to the current period.
• This article defines vertical analysis, describes its process, and provides many trend assessments of current vertical analysis applications.
• This may be due to higher demand or some other factor that needs to be investigated.

In this guide, we explored the methodology of vertical analysis, walked through the steps to perform vertical analysis on income statements, balance sheets, and cash flow statements. We discussed how to interpret the results, considered limitations, and highlighted practical applications. Horizontal analysis is most useful when an entity has been established, has strong record-keeping capabilities, and has traceable bits of historical information that can be dug into for more information as needed. This type of analysis is more specific relevant for analyzing the value we maybe selling or acquiring.

Synergy Between Automation and Data Analytics

Using actual dollar amounts would be ineffective when analyzing an entire industry, but the common-sized percentages of the vertical analysis solve that problem and make industry comparison possible. To do that, we’ll create a “common size income statement” and perform a vertical analysis. Vertical analysis is a method of financial statement analysis in which each line item is listed as a percentage of a base figure within the statement. While performing a vertical analysis, every line item on a financial statement is entered as a percentage vertical analysis definition of another item. For example, on an income statement, every line item is stated in terms of the percentage of gross sales. To perform a horizontal analysis, you must first gather financial information of a single entity across periods of time.

Key Takeaways

For example, the vertical analysis of an income statement results in every income statement amount being restated as a percent of net sales. If a company’s net sales were $2 million, they will be presented as 100% ($2 million divided by $2 million). Lastly, one can evaluate the structural composition of items from the company’s financial statements – for example of assets, liabilities, expenses etc. Vertical analysis is a key tool for FP&A leaders to better understand and evaluate financial statements. It helps in making smarter, strategic decisions by offering a clear view of a company’s financial situation. This approach is vital for planning and guiding a company’s financial future in a straightforward way.

• With the financial information in hand, it’s time to decide how to analyze the information.
• To increase the effectiveness of vertical analysis, multiple year’s statements or reports can be compared, and comparative analysis of statements can be done.
• It offers a better way to perform flux and budget variance analysis by automating the data collection process and integrating with your ERP.
• 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.
• Since every company is different, it can be difficult to compare financial performance or strategic resource allocation, even to direct competitors.

Example 1: Vertical Analysis of Income Statement

The following example shows ABC Company’s income statement over a three-year period. 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. Second, a variance analysis determines not only the dollar amount but the direction of change for a given general ledger account. In order to use the vertical analysis equation, you need to figure out your base figure. On a business’s balance sheet, you can find the relevant base figure as the company’s total assets or liabilities. Though this is dependent on what you are attempting to measure as different financial documents will have different base figures.

Let’s look at vertical analysis in more detail, explore how it works and examine the differences between vertical analysis and horizontal analysis. Vertical analysis looks at the contributing percentage of each line item to the total base figure. It can provide information on what metrics are improving and which are worsening. It can be used to compare different components of companies and the same company in different time periods.

This reveals how business compare in managing their assets and liabilities, income, expenses, and cash flow (regardless of total size). This implies that the new money invested in marketing was not as effective in driving sales growth as in prior years. All of the amounts on the balance sheets and the income statements for analysis will be expressed as a percentage of the base year amounts.

For example, a company’s variable expenses on year 1, 2, and 3 were $151, then $147, and finally $142. Vertical analysis can also be used to compare the companies numbers to competitors or the industry averages. In the event that, for example, the profit per unit falls below a specified threshold percentage, management may consider suspending operations at that particular unit. The management team of a company could use the percentages to set goals and define threshold restrictions using these numbers. If you know your base number, you have something to compare everything else to it, and if you compare each budget item to the base number, you can see where your approach could be weak or strong.