What is Vertical Analysis?

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Vertical analysis is a technique used in financial statement analysis to show the relative size of each account compared to the total amount. Vertical analysis expresses each item on a financial statement as a percentage of the total. Vertical analysis makes it easier to compare companies with different levels of sales or assets by expressing them as percentages rather than absolute amounts. This method can be used for balance sheets, income statements and cash flow statements.To perform vertical analysis, all items are expressed as a percentage of one base figure from the same year-end financial statement. For example, vertical analysis might express an asset, liability or equity account as a percentage of total assets, liabilities or equity respectively.

Definition

Vertical analysis is a technique used in financial statement analysis to show the relative size of each account compared to the total amount. It expresses each item on a financial statement as a percentage of a total amount. By expressing items as percentages rather than absolute amounts, vertical analysis makes it easier to compare companies with different sales or asset levels. This method can be applied to balance sheets, income statements, and cash flow statements.

Origin

The origin of vertical analysis dates back to the early 20th century when financial analysts began seeking more effective ways to compare the financial conditions of companies of different sizes. By representing financial statement items as percentages, analysts could more intuitively identify trends and anomalies in financial reports.

Categories and Features

Vertical analysis is primarily applied to three types of financial statements: balance sheets, income statements, and cash flow statements. In a balance sheet, vertical analysis typically expresses each item as a percentage of total assets. In an income statement, revenues and expenses are expressed as a percentage of total revenue. In a cash flow statement, cash flows are expressed as a percentage of total cash inflows or outflows. The advantage of this analysis method is its simplicity and intuitiveness, but a disadvantage is that it may overlook the importance of absolute amounts.

Case Studies

Case Study 1: When analyzing Apple Inc.'s financial statements, analysts used vertical analysis to express each asset item on the balance sheet as a percentage of total assets. This allowed analysts to quickly identify Apple's investment proportions in different asset categories. Case Study 2: In analyzing Walmart's income statement, vertical analysis helped analysts express each expense and revenue item as a percentage of total revenue, making it easier to compare changes in expense structure across different years.

Common Issues

Common issues include whether vertical analysis overlooks the importance of absolute amounts. The answer is that while vertical analysis provides a perspective of relative proportions, investors should still consider absolute amounts for a comprehensive analysis. Additionally, the comparability of vertical analysis may be limited under different accounting policies.

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