What is Vertical Analysis Formula?
Vertical analysis is a kind of financial statement analysis wherein each item in the financial statement is shown in the percentage of the base figure. It is one of the popular methods of financial statements used as it is simple and also called a common size analysis. Here all the items in the income statement are stated as a percentage of gross sales. All the items in the balance sheet are stated as a percentage of the total assets. Whereas the opposite of the vertical analysis of financial statements is the Horizontal analysisHorizontal AnalysisHorizontal analysis interprets the change in financial statements over two or more accounting periods based on the historical data. It denotes the percentage change in the same line item of the next accounting period compared to the value of the baseline accounting period.read more always looks at the amount from the financial statement over the horizon of many years.
Vertical Analysis formula
In the vertical analysis of financial statements, the percentage is calculated by using the below formula:
Vertical Analysis formula = Individual Item / Base Amount *100
Vertical analysis formula for the Income Statement and Balance Sheet are given below –
To increase the effectiveness of vertical analysis, multiple year’s statements or reports can be compared, and comparative analysis of statements can be done. This analysis makes it easier to compare the financial statements of one company with another and across the companies as one can see the relative proportion of accounts.
Example of Vertical Analysis Formula
Example of the vertical analysis of the financial statement, which shows the total in amount and percentage.
Where the total sales of company A are $1000000 and the cost of goods soldCost Of Goods SoldThe cost of goods sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.read more is $400000. Salary paid to the workers of the company is $300000 office rent paid is $30000, utilities worth $40000 and other expensesExpensesOther expenses comprise all the non-operating costs incurred for the supporting business operations. Such payments like rent, insurance and taxes have no direct connection with the mainstream business activities.read more are $60000.
Vertical Analysis Formula = Individual Item / Total Sales * 100
The above vertical analysis example shows the net profit of the company where we can see the net profit in both amount and percentage. Where the same report can be used to compare with other industry. Where the income statement can be compared with previous years, and the net income can be compared where it helps to compare and understand the percentage of rising or loss of income percentage.
The below vertical analysis example helps to understand the comparison.
In the above vertical analysis example, we can see that the income decreases from 1st year to 2nd year, and the income increases to 18% in the 3rd year. So by using this method, it is easy to understand the net profit as it is easy to compare between the years. In that, we can easily understand that the total expenses gradually increased from 43% to 52%, and the net income got reduced from 1st year to 2nd year. In the 3rd year, the COGS got decreased when compared to the previous years, and the income got increased.
Let us now calculate the Vertical Analysis of the Balance Sheet with the help of another example.
Vertical Analysis Formula = Individual Item / Total Assets (Liabilities) * 100
The information provided in the balance sheet provides the change in working capitalChange In Working CapitalThe change in net working capital of a firm from one accounting period to the next is referred to as the change in net working capital. It is calculated to ensure that the firm maintains sufficient working capital in each accounting period so that there is no shortage of funds or that funds do not sit idle in the future.read more, fixed income over some time. Where the altered business that requires a different amount on the ongoing fund. The same can be done like the income statement where the previous years can be compared and find out the change in the working capital and fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.read more over time.
Advantages of the Vertical Analysis Formula
- It is one of the easiest methods of financial analysis.
- Vertical analysis of financial statement provides a comparable percentage which can be used to compare with the previous years.
- Different organization statements can be compared as the comparison is made in percentage.
- Vertical analysis is also instrumental in comparing the financial statementsThe Financial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more with the previous year’s statement and analyze the profit or loss of the period.
- Where it helps to understand the percentage/share of the individual items;
- Where it helps to understand the structural composition of the various components like cost, expenses, assets, and liabilities
Disadvantages of the Vertical Analysis Formula
- The vertical analysis of financial statements does not help to make a firm decision as there is no standard percentage or ratio regarding the change in the components of the income statement or the balance sheet.
- The accounting conventions are not followed vigilantly in the vertical analysis.
- The liquidity of the organizationLiquidity Of The OrganizationLiquidity shows the ease of converting the assets or the securities of the company into the cash. Liquidity is the ability of the firm to pay off the current liabilities with the current assets it possesses.read more cannot be measured precisely by using the analysis.
- Quality analysis is not done by using vertical analysis of financial statements as there is no consistency in the ratio of the elements.
Conclusion
This article method is one of the easiest methods of analyzing the financial statement. This method is easy to compare with the previous reports and easy to prepare. But this method is not useful to make firm decisions, and measurement of the company value cannot be defined.
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Recommended Articles
Guide to Vertical Analysis Formula. Here we discuss how to do a Vertical analysis of Financial Statements (Balance Sheet, Income Statement) using its formula along with practical examples and applications. You may learn more about financial statement analysis from the following articles –
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