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. When comparing different financial accounts, vertical analysis is a useful tool and a well-known strategy to use. In addition to the financial success of businesses, when combined with horizontal analysis, vertical analysis allows for the generation of a comprehensive picture of the financial status of an organization. Vertical analysis makes it much easier to compare and contrast the how to calculate vertical analysis financial statements of different companies. Using this ratio, executives can evaluate how different departments are faring financially.

Vertical analysis vs horizontal analysis

• Common-size statements include only the percentages that appear in either a horizontal or vertical analysis.
• The two main ways to conduct vertical analysis is through balance sheets and income statements.
• First, gather the balance sheet figures for each line item, such as cash, accounts receivable, fixed assets, etc.
• 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.
• Again the process involves choosing a base line item and then expressing each line item in the balance sheet as a percentage of that base item.

Apple’s operating expenses increased slightly from 11.24% in 2016 to 11.65% in 2018. This might indicate a rise in operational costs, perhaps due to increased R&D or SG&A, reflecting strategic investments in innovation or higher administrative costs. Such shifts can point to operational improvement opportunities or highlight areas of investment needed for long-term growth.

Vertical Analysis – Formula

The gross margin ratio shows the percentage of total sales revenue that is left after costs of goods sold are deducted. A higher ratio indicates a company is efficiently producing its products or services. The operating margin ratio calculates operating income as a percentage of total revenue. The net profit margin ratio reveals how much net income is generated for each rupee of sales.

Sales

• Monitoring deviations through vertical analysis allows strategic shifts in capital structure.
• This helps identify trends, understand performance relative to peers, and recognize whether the company is improving or facing challenges in specific areas.
• Standardizing financial statements as percentages through vertical analysis helps make comparisons regardless of absolute size differences.
• For instance, if current assets comprise 40% of total assets and long-term debt constitutes 30% of total liabilities and equity, this analysis reveals the company’s asset composition and financial leverage.
• Vertical analysis formulas are used by businesses to compare the proportions of different line items to industry averages or those of other companies in the same industry.

He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small bookkeeping businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.

Why Vertical Analysis is Critical for Advanced Financial Management?

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. The two main ways to conduct virtual accountant vertical analysis is through balance sheets and income statements. In vertical analysis, each line item on a financial statement is expressed as a percentage of a chosen base figure from that statement.

You can do the same for the other items on the income statement to get a comprehensive view of the company’s income and expenses. When looking at the financial statements of your business, it can get quite confusing due to the different figures used. Understanding these key components is vital to the successful execution and interpretation of vertical analysis. By grasping the purpose, importance, and various components of vertical analysis, you can harness its full potential in financial analysis and decision-making. In this guide, we will explore the concept of vertical analysis, its purpose, and why it is crucial in financial analysis.

Vertical analysis’ origins are traced back to the late 1800s, when financial analysts began looking at trends in financial ratios over time. Lastly, one can evaluate the structural composition of items from the company’s financial statements – for example of assets, liabilities, expenses etc. The balance sheet provides a snapshot of a company’s financial position at a specific point in time. The balance sheet helps evaluate the company’s liquidity, solvency, and overall financial health.

Read on to learn more about vertical analysis of a balance sheet, how to perform one, and some limitations and drawbacks of this analytical tool. By using vertical analysis, auditors can agree on a standard set of size metrics that let them compare and contrast numbers with very different values quickly and easily. The vertical analysis formula is simply dividing each individual figure by your base amount, then multiplying the result by 100. The company’s management decides on an initial sum to use as a basis or benchmark for measuring the company’s overall level of performance. In this example, we’re using net sales as the number to express everything as a percentage of. We can see that the cost of goods sold is 50% of net sales, which is a relatively high percentage.