Balance Sheet Vertical Analysis: What It Is and How It Works

This may be due to higher demand or some other factor that needs to be investigated. The shareholder’s funds, as seen in the common-size balance sheet, are 53.33% of the total funds for Y Ltd., whereas, in the case of X Ltd. is 50% only. Like the short-term financial position, the financial position in the long term of Y Ltd. is also better when compared to X Ltd. We often see this approach taken in the earnings announcements for public companies. As it gets more intricate, figuring out which data really matters—and what’s just noise or not relevant to your company’s goals—can be tricky.

Vertical analysis, however, studies the proportions of the total amount represented by the different variables during a single period. Financial statements that include vertical analysis clearly show line item percentages in a separate column. 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. The base item in the income statement is usually the total sales or total revenues. Common size analysis is used to calculate net profit margin, as well as gross and operating margins.

Limitations and Drawbacks of Vertical Analysis

While industry comparisons can be helpful, vertical analysis offers direct, context-specific insights without solely depending on external rules of thumb. The real benefit of vertical analysis lies in its ability to provide a clear overview of how expenses are trending over time, either increasing or decreasing. This offers a concise snapshot of costs, pinpointing areas that might warrant further investigation.

• This approach provides insights into patterns over time, highlighting increases, decreases, or trends.
• When we carry out vertical analysis on the income statement, it shows the top-line sales figure as 100%, and every other item is shown as a percentage of the total sales for that year.
• Vertical analysis can account for businesses of different sizes or those with multiple departments and product lines, making cohort analysis and the process of comparing profitability much easier.
• In this example, we have expressed each line item as a percentage of the revenue, which serves as the base figure.
• This empowers organizations to drive business growth by unlocking the true potential of their financial data and harnessing the advantages of vertical analysis for strategic decision-making.
• Adaptability, a proactive approach, and a willingness to embrace change are essential.
• You can analyze multiple periods separately, then do a horizontal analysis to look for trends.

They often are used to compare one company to another or to compare a company to other standards, such as industry averages. Given the consistent sales growth from year 1 to year 3, it is not surprising that salaries and the marketing expenses of the company have also risen as personnel and marketing spend generally supports sales growth. However these expenses, at the first glance, don’t seem to be significant enough to account for the large fall in net income in year 3.

What Is Vertical Analysis?

Vertical analysis refers to the analysis of specific line items in relation to a base item within the same financial period. For example, in the balance sheet, we can assess the proportion of inventory by dividing the inventory line using total assets as the base item. Nevertheless, she goes on to say that vertical analysis compares other line items of the same financial statement against revenue on the income statement or assets on the balance sheet. Vertical analysis is also called common-size analysis and allows investors, bankers and other users to easily compare how well a company is performing against revenue or assets. Vertical analysis allows you to benchmark a company’s financial performance against industry averages or leading competitors.

For example, some minor adjustments could be to remove the “Revenue (% Revenue)” line item since it is not necessary and offers no practical insights. Further, when working with large data sets, we recommend cleaning up the data to improve the overall visual vertical analysis formula representation of the analysis. Regardless of the placement, the more important factor is to ensure the analysis clearly shows which period it is reflecting. We’ll now move to a modeling exercise, which you can access by filling out the form below.