Vertical Analysis Definition
A Vertical analysis is an evaluation of the percentage or size of a base figure (line item) in a financial statement. This analysis captures all the line items, show their relative sizes and proportion. Basically, line items are the assets (liabilities) reflected in a balance sheet. Assets (cash, accounts receivable, inventory, fixed assets) and liabilities (accrued liabilities, taxes payable, short-term debt, and long-term debt) can be analyzed using the vertical analysis method.
When a vertical analysis of cash flow statements is done, cash inflow and outflow are presented as a percentage of the total cash inflows. Hence, this analysis lists each line item as a percentage of another item.
A Little More on What is Vertical Analysis
Vertical analysis is used across industries for financial purpose. Since it presents a proportional analysis of a financial statement, comparison can be drawn between financial statements for different periods.
Many industries use vertical analysis to measure whether there is an improvement or setback in the performance of the industry. It also reflects how different companies in an industry contribute significantly to the growth and profit margin of the industry.
The presentation of various line items in a financial statement as percentage of sales helps to know how profitable a company is when compared to others. A detailed analysis is useful when comparing each line item to a previously reported period.
This instance of vertical analysis will aid a better understanding of how this method works. If a company has a gross sale amounting to $5 million in which $1 million represents the cost of goods sold, $2 million used for general expenses and a tax rate of 25%, below is how the income statement of that company will look like using vertical analysis method;
Gross sales= 100%
Cost of Goods Sold =20% giving us a gross profit of 80%. That is, ($5 million (100%) – ($1 million (20%) = $4 million (80%).
Further in the calculation;
General and administrative expenses is $2 million (40%)
Operating income is $2 million (40%)
Tax rate of 25% = 500,000 (10%)
Hence, the Net income is $1.5 million (30%)
There are other methods used for the analysis of financial statement, Horizontal analysis is one of them. This method of analysis compares line items in a financial statement with preceding ones. The comparison is done by selecting a baseline (one year entries), then the analysis of other year’s express changes from the selected baseline. For instance, if the analysis of balance sheet for 2014 is selected as baseline, then, the amount of cash listed on the balance sheet at December 31 of 2018, 2017, 2016, 2015, and 2014 will represent the percentage of the 2014 amount.
References for Vertical Analysis
Academic Research on Vertical Analysis
Analysis of small-business financial statements using neural nets, Kryzanowski, L., & Galler, M. (1995). Journal of Accounting, Auditing & Finance, 10(1), 147-170.
Using XBRL to analyze financial statements, Tribunella, T., & Tribunella, H. (2010). The CPA Journal, 80(3), 69.
Introducing XBRL through a financial statement analysis project, Gomaa, M. I., Markelevich, A., & Shaw, L. (2011). Journal of Accounting Education, 29(2-3), 153-173.
Diversification, vertical integration, and industry analysis: New perspectives and measurement, Davis, R., & Duhaime, I. M. (1992). Strategic Management Journal, 13(7), 511-524.
A multivariate study of the economy of the European Union via financial statements analysis, Serrano Cinca, C., Mar Molinero, C., & Gallizo Larraz, J. L. (2002). Journal of the Royal Statistical Society: Series D (The Statistician), 51(3), 335-354.
Vertical trade relationships: the role of dependence and symmetry in attaining organizational goals, Buchanan, L. (1992). Journal of Marketing Research, 65-75.
The Appearance And Development Of The Vertical Income Statement And Its Affect On Managerial Accounting, Güvemli, O. (2006, October). In International Conference on Accounting and Management Information Systems.
Accounting data for value chain analysis, Hergert, M., & Morris, D. (1989). Strategic Management Journal, 10(2), 175-188.
Earnings management and the financial statement analyst, Hall, S. C., Agrawal, V., & Agrawal, P. (2013). Accounting and Finance Research, 2(2), 105.
A” vertical” analysis of crises and intervention: fear of floating and ex-ante problems, Caballero, R., & Krishnamurthy, A. (2001). National Bureau of Economic Research.
A’Vertical‘Analysis of Monetary Policy in Emerging Markets, Caballero, R., & Krishnamurthy, A. (2002).
A vertical analysis of crises and central bank intervention, Caballero, R. J., & Krishnamurthy, A. (2001). Manuscrito, MIT, octubre.