Vertical Analysis: Definition, Examples, Pros and Cons

What Is Vertical Analysis?

Vertical analysis shows the proportion of each item on a financial statement relative to a key total on that same statement. For example:

• On an income statement, items are typically shown as a percentage of total revenue.

• On a balance sheet, items are shown as a percentage of total assets, liabilities, or equity.

• On a cash flow statement, each line can be shown as a percentage of total cash inflows or outflows.

This method simplifies comparison between companies of different sizes and helps identify trends or anomalies in financial structure. It’s especially useful for benchmarking or spotting changes in cost structure, asset allocation, or funding sources.

Why Is Vertical Analysis Important?

Vertical analysis helps stakeholders understand the relative proportions of accounts and performance in relation to each other.

It gives business owners a more detailed view of their financial health compared to just knowing their total assets, liabilities and equity. By comparing the proportions of individual accounts from time period to period, companies can track fluctuations and use them to inform strategic decisions, assisting with financial forecasting.

Vertical analysis can also be used to benchmark a company's performance against industry averages.

What Is the Difference Between Vertical and Horizontal Analysis?

Vertical analysis (or common-size analysis) and horizontal analysis (also known as trend analysis) are two of the most commonly used tools in financial statement analysis. Vertical analysis looks at the proportional representation of each line item on the income statement, balance sheet or cash flow statement by expressing them as a percentage of total sales.

Horizontal analysis, on the other hand, looks at changes over time in different elements of the financial statements, such as revenue, expenses and net profit. It is done by comparing figures from multiple years to identify trends. This helps to determine whether a company’s performance has been improving or declining over time due to various factors, such as competitive pressure and new product launches. By using both vertical and horizontal analyses, businesses can gain a better understanding of their financial position and performance.

Analysis Type	Description	Focus
Vertical Analysis	Looks at the proportional representation of each line item on financial statements by expressing them as a percentage of total sales.	Proportional analysis of financial statements at a single point in time.
Horizontal Analysis	Compares figures from multiple years to identify trends, looking at changes over time in different elements of the financial statements.	Analysis of trends over time to evaluate performance improvements or declines.

 

Advantages of Vertical Analysis

The advantages of vertical analysis include:

• It allows one to easily compare the relative size of different line items on the financial statement, throughout all periods.
• One is able to identify important trends in relation to sales growth or contraction as well as other key elements.
• It helps spot potential problems that may be hidden beneath the surface, such as an increase in costs without corresponding increases in revenue.
• A comparison between various segments under an organization can also be done quickly and accurately through vertical analysis since each segment’s expenses are expressed as a percentage of total sales for the entire organization.
• Vertical analysis helps identify which segments are performing better than others and therefore, helps managers in making decisions.

Disadvantages of Vertical Analysis

The disadvantages of vertical analysis include:

• It is not able to provide any information on the absolute size of various line items, so it can be misleading when comparing two companies of different sizes.
• It does not take into account inflation or other external factors that may cause changes in figures year on year.
• Vertical analysis cannot provide a clear picture of how well a company is doing overall since it only looks at individual components and their proportions within the financial statement.
• Additionally, transactions between related parties, such as subsidiaries, are often excluded from the calculations due to complexities in the accounting process.

Vertical Analysis Example

Let's assume that a company has the following balance sheet:

• Cash: $125,000
• Accounts Receivable: $90,000
• Inventory: $150,000
• Equipment: $150,000
• Total Assets: $515,000

Using vertical analysis on this balance sheet would mean calculating each account as a percentage of total assets.

For example, cash would be 24.2% of total assets ($125,000 / $515,000), accounts receivable would be 17.5% of total assets ($90,000 / $515,000), inventory would be 29.1% ($150,000 / $515,000) and equipment would be 29.1% ($150,000 / $515,000).

 

Vertical analysis is a useful tool for financial statement analysis and helps businesses gain insight into their financial position and performance. However, it has certain limitations that should be taken into account when relying on its output. It is important to combine vertical analysis with other analytical tools, such as horizontal analysis, in order to get a more complete picture of an organization’s financial health.

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