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. This type of analysis enables businesses to view the relative proportions of account balances, compare internal changes over time, and identify trends. It’s an effective tool for comparing a company’s financials to those of competitors and an industry benchmark because it allows for easy, straightforward comparisons across different periods and companies of varying sizes.
- Once we divide each balance sheet item by the “Total Assets” of $500 million, we are left with the following table.
- It can be hard to compare the balance sheet of a $1 billion company with that of a $100 billion company.
- 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.
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- 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.
The assets section is informative with regard to understanding which assets belonging to the company constitute the greatest percentage. Once the historical data from 2021 has been inputted into Excel, we must determine the base figure to use. 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). Despite the benefits and insights that vertical analysis can provide, it’s essential to acknowledge its limitations and drawbacks. For each line item on the balance sheet, divide it by the Total Assets and multiply the result by 100. Let’s look at an example to see how applying the vertical analysis formula might work in the real world.
Vertical Analysis of the Income Statement
These types of financial statements, including detailed vertical analysis, are also known as common-size financial statements and are used by many companies to provide greater detail on a company’s financial position. A vertical analysis is also the most effective way to compare a company’s financial statement to industry averages. 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. ABC Company’s income statement and vertical analysis demonstrate the value of using common-sized financial statements to better understand the composition of a financial statement.
Vertical analysis is the proportional analysis of a financial statement, where each line item on a financial statement is listed as a percentage of another item. This means that every line item on an income statement is stated as a percentage of gross sales, while every line item on a balance sheet is stated as a percentage of total assets. As we’ve already established, vertical analysis involves working through your finance sheet line-by-line in order to compare your entries to one base figure.
Step 3: Calculate the percentage for each line item
Suppose we’ve been tasked with performing vertical analysis on a company’s financial performance in its latest fiscal year, 2021. Performing vertical analysis creates the so-called “common size” income statement and the “common size” balance sheet. 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 vertical analysis formula size of the various cost and profit metrics. 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. The common-sized accounts of vertical analysis make it possible to compare and contrast numbers of far different magnitudes in a meaningful way.
Percentage of Total Assets Calculation
It also shows how a vertical analysis can be very effective in understanding key trends over time. Similarly, in a balance sheet, every entry is made not in terms of absolute currency but as a percentage of the total assets. Performing a vertical analysis of a company’s cash flow statement represents every cash outflow or inflow relative to its total cash inflows.
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. Returning to our example above, a vertical analysis of Jackson Widget Company’s balance sheet would look like this.
Use the insights gained from the vertical analysis in your decision-making processes. Look for items with a significant percentage of Total Assets, as these could represent areas of vulnerability or strength. For example, the amount of cash reported on the balance sheet on Dec. 31 of 2018, 2017, 2016, 2015, and 2014 will be expressed as a percentage of the Dec. 31, 2014, amount. In our case, half of the company’s asset base comprises PP&E, with the rest coming from its current assets.
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. So, in a vertical analysis of a balance sheet, every line item — cash, accounts receivable, fixed assets, accounts payable, stockholders equity, etc. — is shown as a percentage of total assets. In a vertical analysis of an income statement, every line item is shown as a percentage of gross sales. In vertical analysis, each line item in the financial statement is expressed as a percentage of a base figure in the same period (for example, the total assets or gross sales). However, in horizontal analysis, the relative change in a line item from one period to the next is calculated and typically presented as a percentage change.
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. 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. 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. For instance, we can see that our company’s long-term debt as a percentage of total assets is 17.0%.
To overcome these limitations, it’s a good idea to use vertical analysis in conjunction with other financial analysis techniques, such as horizontal analysis or ratio analysis, as well as other financial ratios. When used together, they offer a comprehensive view of the company’s financial health. 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. In ABC Company’s case, we can clearly see that costs are a big reason profits are declining despite the company’s robust sales growth. What we don’t know, and what we can’t know from the vertical analysis, is why that is happening. Converting the raw numbers into percentages provides a clearer picture of the proportion of the asset or liability in the context of the company’s total financial resources.
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. In accounting, a vertical analysis is used to show the relative sizes of the different accounts on a financial statement. This approach provides insights into patterns over time, highlighting increases, decreases, or trends.
The information provided by this income statement format is useful not only for spotting spikes in expenses, but also for determining which expenses are so small that they may not be worthy of much management attention. 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. 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. Compare your results with industry benchmarks or similar companies to see how your business stacks up.
This shows that the amount of cash at the end of 2018 is 141% of the amount it was at the end of 2014. By doing the same analysis for each item on the balance sheet and income statement, one can see how each item has changed in relationship to the other items. Common-size financial statements often incorporate comparative financial statements that include columns comparing each line item to a previously https://simple-accounting.org/ reported period. To reiterate from earlier, dividing by total assets is akin to dividing by the sum of liabilities and equity. Find out a little more about vertical analysis in accounting, including horizontal analysis vs. vertical analysis, with our comprehensive article. First, we can see that the company’s marketing expenses increased not just in dollar terms, but also as a percentage of sales.
We’ll now move to a modeling exercise, which you can access by filling out the form below. Pre-defined best practice account reconciliation templates created by accountants, for accountants. Emma’s 70-person geographically distributed accounting team improved internal controls and streamlined the audit thanks to FloQast. Access and download collection of free Templates to help power your productivity and performance.
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. On the liabilities and shareholders equity side, we’ve chosen the base figure to be total assets. 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 formula to perform vertical analysis on the income statement, assuming the base figure is revenue, is as follows.
You can apply the information you gather through a vertical analysis of your financial documents by comparing particular accounting periods to each other. This helps you get a better idea of general trends in your accounts and any growth or decline that may have occurred over set periods of time. By doing this, we’ll build a new income statement that shows each account as a percentage of the sales for that year. As an example, in year one we’ll divide the company’s “Salaries” expense, $95,000 by its sales for that year, $400,000. That result, 24%, will appear on the vertical analysis table beside Salaries for year one. 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.
