There are various methods for examining the income statement and balance sheet. There are certain ratios that can be used to measure profitability and asset utilization. Financial statements allow the business to stop in time so that entrepreneurs and investors alike can measure the fiscal performance of the company. This article looks at vertical analysis as one method of analyzing financial statements.
Vertical Analysis of the Financial Statements
Vertical analysis compares different categories of the financial statements. The comparison is usually within the same accounting period. Vertical analysis doesn’t normally integrate different financial statements. In other words, comparison is made between different accounts of the same financial report. Thus the analysis is done vertically, or up and down on the same financial statement. The comparisons that are made generally have a financial affect on each other.
Vertical Analysis of the Income Statement
When it comes to the income statement, vertical analysis can be used to compare revenue account categories, expense categories or expense accounts against revenue categories. Below is an example of vertical analysis in the revenue section of the income statement for separate sales categories compared to total sales. In this example, let’s use a company in the business of selling fruit.
Total Fruit Sales $50,000
- Apples $15,000 – 30% of sales
- Oranges $14,000 – 28% of sales
- Bananas $11,000 – 22% of sales
- Pears $10,000 – 20% of sales
Expenses are also compared to either total revenue or to gross profits. There are usually two basic expense categories, fixed and operating expense. Since operating expenses tend to fluctuate more with sales activities, vertically analyzing operating expenses against revenue is more important to profitability. Below is an example of vertical analysis of operating expense compared to total sales.
Total Fruit Sales $50,000
- Hourly Wages $3,000 – 6% of sales
- Sales Commission $4,000 – 8% of sales
- Advertising $2,000 – 4% of sales
- Freight $1,000 – 2% of sales
Vertical Analysis of the Balance Sheet
Examining the balance sheet, vertical analysis is used to compare asset account categories, liability account categories or liability accounts against asset accounts. Owner’s Equity can also be compared to assets and liabilities. Below are some examples of vertical analysis of balance sheet accounts.
Total Current Assets $100,000
- Cash $12,000 – 12% of current assets
- Accounts Receivable $50,000 – 50% of current assets
- Inventory $38,000 – 38% of current assets
Current Assets Compared to Current Liabilities
- Total Current Liabilities $40,000
- Current Liabilities to Current Assets = 40%
For better examination of the financial statements, vertical analysis should be used in conjunction with horizontal analysis. By comparing the results of current conditions to historical data, the entrepreneur gets a better understating of the financial direction of the company. It also allows the entrepreneur to look for negative trends in profitability, find the root cause and take appropriate action.
James Clausen - Clausen received a Bachelors Degree in Business Administration in Automotive Management and Marketing at Northwood University, graduating ...
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