Vertical Analysis Common Size Analysis Explained

A common size financial statement allows for easy analysis between companies or between periods for a company. It displays all items as percentages of a common base figure rather than as absolute numerical figures. To prepare a vertical analysis, you select an account of interest and express other balance sheet accounts as a percentage. For example, you may show merchandise inventory or accounts receivable as a percentage of total assets. A good way to do some ratio and trend analysis work is to prepare both horizontal and vertical analyses of the income statement. Both analyses involve comparing income statement accounts to each other in dollars and in percentages. Moreover, it also helps compare the numbers of a company between different time periods , be it quarterly, half-yearly, or annually.

• This would mean that the ratio of years 1, 2, and 3 to year one would be 100%, 97%, and 94%, respectively.
• This implies that the new money invested in marketing was not as effective in driving sales growth as in prior years.
• Hence, it may not be easy to make any decision based on such analysis and looking at the change in the percentage of various income statement components.
• Vertical analysis is a proportional analysis of financial statements.
• Horizontal analysis is the comparison of historical financial information over a series of reporting periods, or of the ratios derived from this financial information.

In ABC Company’s case, we can clearly see that costs are a big reason profits are declining despite the company’s robust sales growth. What we don’t know, and what we can’t know from the vertical analysis, is why that is happening.

How Is Vertical Analysis Different From Horizontal Analysis?

It is also useful in comparing a company’s financial statement to the average trends in the industry. It would be ineffective to use actual dollar amounts while analyzing entire industries. Common-size percentages solve such a problem and facilitate industry comparison.

Vertical analysis can be used both internally by a company’s employees and externally by investors. Investors can use vertical analysis to compare one company to another. Vertical analysis also makes it easy to compare companies of different sizes by allowing you to analyze their financial data vertically as a percentage of a base figure. In horizontal analysis, you can compare figures from one time period to figures from a base time period to get an overview of changes over time. Analyzing financial trends over periods or years can help you track how a company’s financial state has changed, find patterns in its data and spot potential problems and opportunities. This type of analysis can also help a company secure investors. Investors, who often conduct comprehensive research into a company’s financial statements, can use financial analysis to make sense of a company’s financial data and compare one organization to another.

B) sales.

Used to evaluate a company’s solvency and long-term debt paying ability. Calculated by subtracting current liabilities from current assets.

At the bottom of the analysis, note that net income, as a percentage of sales, declined by 2.62 percentage points (6.67 percent to 4.05 percent). As a dollar amount, net income declined by $14,096 ($33,333 to $19,237). Management should consider both the percentage change and the dollar amount change. If both companies have similar levels of net sales and total assets, it is reasonable to assume that the more profitable company is the better performer. It does not help take a firm decision owing to a lack of standard percentage or ratio regarding the components in the balance sheet and income statement. For example, if the base amount is gross sales of $50,000, and the analysis amount is selling expenses of $5000. Then the percentage will be 10% ($5,000/$50,000).

Using horizontal analysis

Notice that the column presenting the ratio of each line item to gross sales is to the right of the actual values. Sometimes, financial statements are prepared in this way by the provider but often FP&A analysts will utilize their own basis depending on what information they are trying to understand. The issue with only performing horizontal analysis is that it presents one line item as it pertains to itself. Therefore, it is important to see the total picture by combining horizontal and vertical analysis. By doing this analysis get an idea of how line items compare to themselves over time and whether those changes make sense in the context of the current time period as well.

For example, the amount of cash reported on the balance sheet on December 31 of 2018, 2017, 2016, 2015, and 2014 will be expressed as a percentage of the December 31, 2014, amount. in performing a vertical analysis, the base for sales revenues on the income statement is Instead of dollar amounts, you might see 141, 135, 126, 118, and 100. Waters Department Store had net credit sales of $8,000,000 and cost of goods sold of $6,000,000 for the year.

Implementing vertical analysis

You realize that a declining net profit margin isn’t good, but you wonder how you compare with your industry. A little research informs you that average net profit margin in the industry is https://online-accounting.net/ 7 percent. You performed nearly as well as the industry in year 1 but fell further from your target in year 2. That a goal for year 3 should be trying to increase your net profit margin.

This base account is the account title which is assumed to be 100% and is used as a dividend in obtaining the percentage of the other accounts. Horizontal analysis can be performed by comparing a recent year against the base year while identifying the growth trends between the time periods. The analysis can be performed in any four types of financial statement i.e. income statement, balance sheet, statement of cash flow, and statement of changes in equity. However, income statement and balance sheet are mostly used financial statement to do horizontal analysis .

The following information pertains to Blue Flower Company. Assume that all balance sheet amounts represent both average and ending balance figures.

• If you get a fairly low-paying job and your income is only 3 times the amount of your interest payment, you’ll have trouble making your payments.
• The calculated percentage value is used in the table above.
• If the accounts payable are $88,000 they will be restated as 22% ($88,000 divided by $400,000).
• The following example shows ABC Company’s income statement over a three-year period.
• You can see that the company’s total assets increased by $300,000.
• Vertical analysis, which is also known as common-size analysis, is similar to horizontal analysis and can be performed on the same financial documents.
• Vertical analysis is used in order to gain a picture of whether performance metrics are improving or deteriorating.