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Vertical Analysis (Common-Size Analysis)
Definition of
Vertical Analysis (Common-Size Analysis)
What is Vertical Analysis (Common-Size Analysis)? Vertical analysis, also known as common-size analysis, is a method of financial statement analysis in which each line item on a financial statement (like the Income Statement or Balance Sheet) is expressed as a percentage of a base figure within that same statement for a single period. For the income statement, all items are typically shown as a percentage of total sales revenue. For the balance sheet, items are usually expressed as a percentage of total assets or total liabilities and shareholders' equity.
Activities Related to
Vertical Analysis
Here is a list of activities related to Vertical Analysis: Selecting a base figure for each financial statement (e.g., total sales for the income statement, total assets for the balance sheet). Calculating each line item as a percentage of the selected base figure for a single accounting period. Presenting the financial statements in a "common-size" format with these percentages. Analyzing the relative size or proportion of each line item. Comparing these proportions across different companies in the same industry (benchmarking) or over different periods for the same company to spot structural changes. This type of analysis is essential for creating insightful financial reports.
The Importance of
Vertical Analysis
Vertical analysis is important because it allows for the easy comparison of the relative proportions of financial statement items, regardless of the absolute size of the company. This makes it particularly useful for comparing companies of different sizes within the same industry or for analyzing how the internal structure of a company's finances (e.g., its cost structure or asset composition) has changed over time. It helps in identifying significant components of revenue, expenses, assets, and liabilities, and can highlight areas of concern or strength. It is often used alongside Horizontal Analysis for a more complete picture.
Key Aspects of
Vertical Analysis
Proportional Analysis
Shows each item as a percentage of a significant total within the same statement.
Single Period Focus
Primarily analyzes the relationships within one accounting period, though results can be compared across periods.
Common-Size Statements
Creates financial statements where all items are expressed as percentages, facilitating comparisons.
Insight into Structure
Reveals the internal financial structure of a company, such as the makeup of its expenses or assets. Accurate bookkeeping is essential for reliable data.
Concepts Related to
Vertical Analysis
Vertical Analysis is a technique used in Financial Statement Analysis, alongside Horizontal Analysis and Financial Ratios. It involves restating financial statements into a common-size format. For example, on a common-size Income Statement, Gross Profit Margin and Net Profit Margin are direct outputs of this analysis.
Vertical Analysis
in Action:
The Adventures of Coco and Cami
Coco looks at her bakery's Income Statement. Professor A shows her Vertical Analysis: they express each expense, like ingredients and rent, as a percentage of her total sales revenue. This helps her see what proportion of her sales is eaten up by each cost.
Cami applies vertical analysis to her boutique's Balance Sheet, showing each asset (like cash and inventory) as a percentage of her total assets. This helps her understand the composition of her assets and compare it to other boutiques. This is a powerful tool in financial statement analysis.