Vertical Analysis: Explained

What is it, how to calculate it, formula, why it's important

Hey there, fellow marketers! 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.

What is Vertical Analysis?

Vertical analysis is a technique used to analyze financial statements. It involves breaking down each line item on a statement and expressing it as a percentage of another number on the statement. This is usually done by expressing everything as a percentage of net sales, but it can also be done relative to other numbers on the statement, such as gross profit or total assets.

By expressing each line item as a percentage of another number, vertical analysis allows you to see how much of a company's revenue is being spent on various expenses or how much of certain assets are being invested in other areas of the business.

Why is Vertical Analysis Useful?

Vertical analysis can be incredibly useful for a few different reasons. For one thing, it allows you to see how much of a company's revenue is being spent on certain expenses. This can help you identify areas where there may be inefficiencies or where costs could be cut.

Vertical analysis can also help you see how a company's expenses are affecting its bottom line. If you see that a company is spending a large percentage of its revenue on certain expenses, you can dig deeper to see if those expenses are justified or if there are opportunities to reduce costs.

How to Perform Vertical Analysis

Performing vertical analysis is relatively straightforward. All you need are the financial statements you want to analyze and a calculator. Here's a step-by-step guide:

  1. Choose the financial statement you want to analyze. This could be an income statement, balance sheet, or cash flow statement.
  2. Choose the number you want to express everything as a percentage of. This is usually net sales.
  3. Calculate the percentage that each line item is of the number you chose in step 2.
  4. Compare the percentages for each line item to historical data or to industry averages to see if there are any red flags.

Examples of Vertical Analysis

To give you a better idea of what vertical analysis looks like in practice, here are a couple of examples:

Income Statement Example

Line Item Amount Percentage of Net Sales
Net Sales $100,000 100%
Cost of Goods Sold $50,000 50%
Gross Profit $50,000 50%
Salaries and Wages $20,000 20%
Rent $10,000 10%
Advertising $5,000 5%
Net Income $15,000 15%

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. This could indicate that there are inefficiencies in the company's supply chain that need to be addressed.

Balance Sheet Example

Line Item Amount Percentage of Total Assets
Current Assets $100,000 40%
Property and Equipment $150,000 60%
Total Assets $250,000 100%

In this example, we're expressing everything as a percentage of total assets. 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.

Conclusion

Overall, vertical analysis is a powerful tool that can help you gain a better understanding of a company's financial health. By breaking down each line item on a financial statement and expressing it as a percentage of another number, you can identify areas where there may be inefficiencies or potential opportunities for cost savings.

If you're not already using vertical analysis in your financial analysis, I highly recommend giving it a try. I think you'll find that it's a valuable addition to your toolkit.

Thanks for reading, and happy analyzing!

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