Vertical Analysis - Online Tutor, Practice Problems & Exam Prep

Vertical analysis is a method used to evaluate financial statements by expressing each line item as a percentage of a base amount. For the income statement, net sales serve as the base, while total assets and total liabilities and equity are used for the balance sheet. This analysis helps in understanding the proportion of expenses and profits relative to sales, revealing insights into cost management and profitability. For example, if cost of goods sold is 83.9% of net sales, it indicates that a significant portion of revenue is allocated to production costs.

Vertical Analysis

So it's important to be able to analyze financial statements as well as create them in this class. Well, another way we can analyze them is through a vertical analysis. Let's check it out. So you may have previously learned about a horizontal analysis where we do a percentage change from 1 year to the next. If not, you'll learn about it in a different video. Here we're going to learn about the vertical analysis. A vertical analysis is still dealing with percentage changes, but we're not dealing with year over year changes anymore. We're going to be dealing with a percentage of the base amount on the financial statement. So we're going to do this for the income statement and the balance sheet. So let's see what the base amount is going to be for each of those statements.

On the income statement, our base amount is going to be our net sales. Our net sales or just our sales revenue, right? Or our sales revenue if we don't have a net sales amount. We're going to use that top line, sales revenue. Whatever the top line is on your income statement, that's what we're using as our base. And then we're going to have on the balance sheet, our base is going to be our total assets and we're also going to use so for the assets part, we're going to use total assets And for the liabilities and equity, we're going to use total liabilities and equity. But remember, these numbers are the same, aren't they, right? Total assets equal total liabilities and equity. So they're going to be the same number. So either way, we're going to have that number, as our balance sheet base.

What do I mean when I say base? That's what we're going to use as the denominator in our percentage formula. So remember that when we find the percentage of the base, what we're going to do is we're going to take the line item amount, say, selling expense like we have down here and we're going to divide it by the base amount. So if that was on the income statement, it would be the selling expense, whatever that amount is for the year divided by the net sales, because we're dealing with the income statement. And remember that we're getting a percentage, so we are going to multiply this by 100 to move the decimal place 2 places and get a percentage.

Let me go ahead and show you how we do a vertical analysis here on an income statement and then you guys can get some practice on a balance sheet. So let's go ahead and do it for 2 years here. We've got 2018 and we've got our net sales. So remember that net sales, this is our base amount. This is always going to be the denominator. In every single one of our calculations, the base amount is net sales for that year. So 2018, the base amount is always going to be 65455 and when we do 2017, it'll always be 58081.

Let's go ahead and do a couple of them and then I'm going to speed it up. I've done a lot of these calculations ahead of time. It's just going to be a lot of number crunching, that's why we became accountants because we love using our calculator. Hit all those buttons. Let's go ahead and do it. So net sales, this one's always going to be 100%, right? It's going to be 100% of itself. This calculation, we would do 65455, the line item amount divided by the base amount which is net sales. So that's going to be obviously 1, we multiply it by 100 to get the percentage and that one is 100%. So net sales is 100% of itself. Wow, that's very revealing information. Let's go on down and we'll start getting some better information.

How about cost of goods sold? So remember the numerator is going to be the line item. So 54912 is our numerator and we divide it by net sales, right? Net sales is always going to be the denominator. 65455. Alright. So let's go ahead and you just do that division and we'll get it as a percentage and we see that it's 83.9%. I'm going to be rounding just to one decimal here.

We can do our vertical analysis to subtotals as well. Remember, gross profit is a subtotal. It's not its own expense or revenue. It's a subtotal. It's just net sales minus cost of goods sold. Well, we can find out what gross profit is out of net sales. So you do the same thing, 10543 divided by net sales, the same number 65455 and we get it as a percentage. We multiply by 100 to get a percentage and we'll get 16.1%.

Already we can see that out of net sales, 83%. So for every dollar of net sales, almost 84% of it is going to pay for the cost of goods sold and we're left with 16% at this point. And then we still got to pay for other stuff. We're going to have other expenses and we're going to end up with our net income. So this lets us know how much of a percent of net sales. So we get a dollar of sales, how much of that is going to different places.

Let's keep going here with our operating expenses. So I'm going to write this one out, but after this, I think you should get the point of how we do this calculation and I'm going to start putting in our percentages. So 2411, right? Our line item is our numerator divided by 65455 still using that same, net sales amount as our numerator, and let's go ahead do that division and we get 3.7%. We keep going 982 divided by 65455 and we get 1.5%. So we know for every dollar of sales, what 1.5% of that is going to selling expenses. Maybe some commission we pay to our salesperson, they get 1.5% off of every sale. Depreciation expense, 1400 divided by 65455. Same thing. 2.1% here and we can do it with total operating expenses. How much are our total operating expenses as a percentage of our sales? And we get 7.3% here.

Another subtotal, income from operations, right? This is where we take our gross profit minus those operating expenses. This is all of our core business. How much are we making? Well, 5750 out of that 65455 that comes out to be 8.8%. That means for every dollar of sales, well, we're keeping 8.8% from operations, and then we've got a couple more things we got to pay for, and then we're left with our net income.

So let's do those. Next, we've got interest expense, 480 divided by 65455 and we're going to get 0.7%. How about the next one? Other expenses, look how small this is $70. That doesn't seem like a very big part of net sales. We do our calculation 70 divided by 65455, 0.1%. Vertical analysis is pretty easy, right? We're just doing this simple division. All you g

Vertical Analysis

Alright, so let's run through 2017 and do our income statement vertical analysis. Notice, this time we're still dealing with the same base. Our base is still net sales, but we've got to use the 2017 number, right? Now we're going to use 58081 as our denominator. Okay? Before we were using 65455 as the denominator because it was 2018. Well for 2017, we use their net sales number and it's going to be the same thing, right? We're going to see that, for net sales, well, it's always going to be 100%, right? It's always 100% of itself because it is our base. Cool? So let's start going down. I'll write a couple of these out and then we'll see, that it's very much the same as what we did.

The cost of goods sold is 45377, right? This is our cost of goods sold divided by 58081 and that gives us 78.1%, once we multiply by 100 there. We do the same thing with gross profit. 12704 divided by 58081. Right? Same base amount all the way down and it's going to be 21.9%. And this should make sense, right? If we have 100% in net sales and 78.1 went to pay for the cost of goods sold, well, whatever leftover is gross profit. So the 100% minus the 78.1 should be 21.9 and it is, right? This should make sense, right? We kept the 21.9 and this is where it starts to be beneficial too. Not only can we make that analysis going down, but now we can compare year by year too. We can kind of do some sort of horizontal analysis with our vertical analysis where we see that we had 16.1% as our gross profit in 2018 and 21.9% in 2017. So that's gone down a bit, that could be important information to an investor, to a bank that's loaning us money, right? They would like to know this information. Even the company itself gets good information out of this. So let's keep going down here.

The next one, well rent expense, it didn't change year over year, 2411 but it's coming out of less net sales, right? So we can imagine it's going to be a bigger percentage because we've got a smaller denominator. So that's going to be a bigger percentage of it. So right now, it's 4.2%. Once we do that and multiply by 100, we get 4.2%. Cool? So you can see the math is very much the same as what we did in 2018.

I'm going to start going down a little faster here. The depreciation expense is 902, this one is 1.6%. Right? This is 902 divided by our net sales of 58081, and let's just keep going down.

Total operating expenses, 4184 divided by 58081 gives 7.2%. And the next one, 8520 in our numerator, and we get 14.7%. How about interest expense? Well, 400 divided by the net sales, and we get 0.7%. Other expenses are 120 divided by 58081, giving 0.2%. We're left with our income before taxes at this point, and we just do our 8000 divided by the net sales and it tells us that income before taxes is 13.8 percent of net sales.

Our income tax of 3,200, well that's going to be, 32100 divided by the net sales is 5.5%, and finally, our net income. So we're left with 48100 at the end of the day off of net sales of 58081 and we get 8.3%, okay? So this is a big part of the vertical analysis is that bottom line, right? We can see that for every dollar of sales in 2017, we get to keep 8.3¢ after all of our expenses. Where in 2018, we only got to keep 4.8¢ for each dollar, right? So that's a big red flag maybe to investors. What's going on with the expenses? Maybe they're getting a little out of control, so they can do a little more analysis with that information.

Cool? So you can see a vertical analysis is pretty straightforward. Now why don't you guys try it with the balance sheet? Remember, we're going to have a different base amount on the balance sheet. So check what we called above and go ahead and try it before watching the next video and we'll go through it together. Alright, let's do it.

Complete a vertical analysis of the following balance sheet:

Alright, so let's go ahead and complete our vertical analysis of a balance sheet. Remember that on the balance sheet, our base amount is different than on the income statement. On the income statement, we use net sales or sales revenue, whatever our top line is. And for the balance sheet, we're going to use total assets or total liabilities and stockholders' equity, right? This is our base amount right here. And it could also be this one. Notice they're the same number, right? They should be the same because assets equal liabilities plus equity. So, we've got 71707, 71707. So they're going to be the same, whichever one you pick as long as you're consistent, it doesn't matter. 71707 is going to be our denominator throughout all of these calculations. So let's go ahead and start with cash. Our numerator is going to be 26211 and we're going to divide by our denominator which was the total assets amount, total liability stockholders' equity. It's 71707, right? So notice, this denominator is going to be consistent just like we did with the income statement with net sales. We've got a consistent denominator here for our vertical analysis. So we do that division, put it as a percentage by multiplying by a 100 and we're going to get 36.6%. Okay. So, cash, what this tells us is that of our total assets, 36.6% of it is cash, right? We've got 36.6 percent of our assets in cash. Let's keep going here with accounts receivable and we have 15912 divided by the same denominator, right? That's the beauty of vertical analysis, as the denominator is not going to change. So we do that, get a percentage 22.2%. Okay? So, 22.2% of our assets are accounts receivable. Let's do inventory. 6424/71707, and that gives us 9.0%. Alright. Last but not least, we've got PPE, our property plant, and equipment. These are long-term assets, fixed assets. 23160/71707, and we're going to get notice in your calculator, you probably got something closer to 32.3, right? But remember, we've just broken down our assets. The 100% of assets that we have, we've broken it up into 4 different categories for the 4 different types of assets. Well, that should equal a 100%. And notice, if you put in 32.3 right now, we would have a rounding error and it would come out to 100.1%. So what I'm going to do is at this point, I'm going to round this one to 32.2% because it's going to keep the totals here. If we add all 4 of these numbers, 36.6 plus 22.2 plus 9 plus 32.2, it's going to equal a 100%. Okay? So that's one little thing with vertical analysis is that you want to make sure that your totals still come out to a 100%. Right? So 71707/71707 equals 100%, right? So there's our 100%. Now you could have rounded any of them. It doesn't matter which one you rounded as long as you get that total of 100%. So that's just one thing to be a little careful of, just to make sure it comes out to 100. Cool? Alright. Let's go ahead and do our liabilities and equity here. So remember, our base is still going to be 71707 even though now we're technically using this 71707. Well, it's the same number. So let's do accounts payable 95 whoops, 9562/71707, and that gives us 13.3%, Right? So how did we finance these assets? Well, 13.3% of the financing is in accounts payable, is in some short term money that we owe to suppliers and things like that. Cool? So I think you get the picture. I'll do one more here. 6117/71707, and our accrued expenses are 8.5%, right, and we'll keep going down like that. 30000/71707, well that's going to equal 41.8%. So 41.8% of our assets are financed with long-term debt. That's good information for the investors, right? There seems to be quite a good chunk of debt financing these assets. Cool. Let's keep going. Common stock, the common stock, 1000/71707, 1.4%. APIC, our additional paid-in capital, another equity account, 19000. So same thing, 19000/71707, we get 26.5% and retained earnings. Right? So this is the same thing as above. At this point, you want to double-check to make sure that you're going to total a 100%. And when you do your retained earnings 6028/71707, you'll probably get something, I think closer to 8.6%. I don't really remember. But whatever it is, you want to make sure that your total is 100%. Right? So when you total all of these numbers, you'll see that you wouldn't get 100%. You'd be off by 0.1. So what I did is I rounded it to 8.5%. Right? It's not a big deal. We're just dealing with very small decimals. We're just rounding here. Cool. So we get 8.5%. Let me clean that up a little bit. 8.5 percent and you'll see that our total of all of our liabilities and equity, if we add all those percentages together, they will equal 100% and that's what we get in this last one, right? 71707/71707, that equals 100% down here. Cool? Alright. Let's pause here and let's do the same thing for 20X1. Let's get a little more practice with our vertical analysis.

Complete a vertical analysis of the following balance sheet:

Alright, so this is going to be really similar to what we did in 20X2, except we have to change our base amount to the 20X1 number, right? So we're no longer going to be using the 71707; we're going to be using this number over here, 70112, right? The same number down here for our liabilities and equity, that is going to be our new base for this year. Cool? Alright. Let's go ahead and do it. 18514 in cash divided by the base of 70112. That's going to give us 26.4%, right? 26.4% of our assets are cash. Let's do the same thing for accounts receivable, 18530 divided by our base of 70112 and that one pretty much is 26.4 as well. Right? So, those numbers are pretty close. You can see that they're going to be pretty much the same percentage. Alright. Let's keep going. Our inventory, 16028 divided by 70112. Whoops. And we get 22.9%. So notice inventory year over year, they're quite different numbers. In 20X1, we had quite a good substantial chunk of our assets in inventory. And in 20X2, it's gone down quite a bit. Maybe we've become more efficient, right? Maybe we don't need to hold as much inventory because we've gotten better at managing our inventory. This could be a good thing. Cool. Let's go on with PPE. So PPE, property plant and equipment, 17040 divided by our same base 70112, and we get 24.3%. So notice this one, we didn't have to do any special rounding because these numbers once we did our one decimal rounding, well, it still came out to a 100% when we added all 4 together. So good on us, we don't have to do any extra rounding there, and we get a 100% of our total assets are total assets. That makes sense. Cool. So let's do the same thing down here with accounts payable. And let me go ahead and just get out of the way. So I'm not there. Alright. Let's go ahead and do this one. So 13759, well, what's going to be our base here? Same thing, right? 70112. Vertical analysis, so fun. Okay, 19.6%, cool. Alright, I'm going to start stop writing all of this out and I'm just going to give you the percentages here. So 6241 divided by our same base for accrued expenses, 8.9%. Going down long-term debt, 25000, well, 35.7%, right? 25000 divided by our base. Keep going common stock, 1000 divided by our base, and we get 1.4%. APIC, 19000 divided by our base, and we get 1900070112, yielding 27.1%, and finally retained earnings. So at this point, I would double-check. I would do my calculation and then double-check that I'm going to total to a 100 percent. 511270112 and we get 7.3%. And those numbers do add up to a 100, right? If we total all those up, we get a 100% and we are good to go. So let's do our final one and remember, this is just 7112 divided by 7112, and this will always be a 100% of itself. Cool? Alright. So that is how we do our vertical analysis here on a balance sheet. A little more complicated than on the income statement because you just have to remember that it's the total assets or the total liabilities. Honestly, it's hard to say that that's very complicated at all. Right? So the main thing is being able to use this information now to make good decisions. Alright? Let's go ahead and move on to our next video.

Here’s what students ask on this topic:

What is vertical analysis in financial accounting?

Vertical analysis is a method used to evaluate financial statements by expressing each line item as a percentage of a base amount. For the income statement, the base amount is net sales, while for the balance sheet, the base amounts are total assets and total liabilities and equity. This analysis helps in understanding the proportion of expenses and profits relative to sales, revealing insights into cost management and profitability. For example, if cost of goods sold is 83.9% of net sales, it indicates that a significant portion of revenue is allocated to production costs.

How do you perform vertical analysis on an income statement?

To perform vertical analysis on an income statement, follow these steps: 1) Identify the base amount, which is net sales. 2) For each line item, divide the amount by the base amount (net sales). 3) Multiply the result by 100 to convert it to a percentage. For example, if net sales are $65,455 and cost of goods sold is $54,912, the calculation is: $\frac{54912}{65455}\times \; 100\; =\; 83.9\%.\; This\; means\; that\; 83.9\%\; of\; net\; sales\; are\; used\; to\; cover\; the\; cost\; of\; goods\; sold.$

What is the base amount used in vertical analysis for the balance sheet?

In vertical analysis for the balance sheet, the base amounts are total assets and total liabilities and equity. These two figures are equal, so either can be used as the base. For example, if total assets are $100,000, each line item on the balance sheet is expressed as a percentage of this $100,000. This helps in understanding the proportion of each asset, liability, and equity item relative to the total assets or total liabilities and equity.

Why is vertical analysis important in financial statement analysis?

Vertical analysis is important because it provides a way to compare financial statements of different-sized companies or different periods within the same company. By expressing each line item as a percentage of a base amount, it standardizes the data, making it easier to identify trends and make comparisons. This analysis helps in understanding cost management, profitability, and financial health, offering insights into how effectively a company is managing its resources and generating profits.

How does vertical analysis differ from horizontal analysis?

Vertical analysis differs from horizontal analysis in that it focuses on the relationship of each line item to a base amount within a single financial statement, expressed as a percentage. Horizontal analysis, on the other hand, compares financial data across multiple periods, showing the percentage change from one period to the next. Vertical analysis helps in understanding the structure and composition of financial statements, while horizontal analysis helps in identifying trends and growth patterns over time.