# Vertical Analysis Common Size Analysis Explained Perform a vertical analysis of Theta Designs’s balance sheet for each year. For example, suppose in Income Statement COGS is \$400,000 and sales is \$1,000,000 then, in that case, COGS percentage is 40% is computed by dividing COGS amount of \$400,000 with the base item of Sales i.e. \$1,000,000. In general, managers prefer expenses as a percent of net sales to decrease over time, and profit figures as a percent of net sales to increase over time.

• That is, for the income statement, each item is measured as a percent of net sales, and for the balance sheet, each item is measured as a percent of total assets (or total liabilities and shareholders’ equity).
• Vertical analysis is used to analyze the different accounts of the financial statements and describe the changes in the relative size of each item.
• In a vertical analysis, you would use financial information each year to calculate the relationship of each line item to a base amount.
• If a company has a gross sale amounting to \$5 million in which \$1 million represents the cost of goods sold, \$2 million used for general expenses and a tax rate of 25%.
• For example, by showing the various expense line items in the income statement as a percentage of sales, one can see how these are contributing to profit margins and whether profitability is improving over time.

That is, for the income statement, each item is measured as a percent of net sales, and for the balance sheet, each item is measured as a percent of total assets (or total liabilities and shareholders’ equity). Another form of financial statement analysis used in ratio analysis is horizontal analysis or trend analysis. Net sales are used as the base for the income statement, and total assets (or total liabilities and shareholders’ equity) are used as the base for the balance sheet. The vertical analysis of financial statements focuses on the relationship of different components to the total amount. See how the vertical method is used in examples of balance sheets and income statements.

## Step 4: What item is used as the base for the balance sheet?

The total revenue is taken as a base item, and other heads of the income statement are presented as a percentage of the base figure. Vertical analysis is used to analyze the different accounts of the financial statements and describe the changes in the relative size of each item. It is a management tool used by companies in analyzing the changes in the relative size of different accounts over several years. It is also helpful in comparing the financial statements of two companies with the industry average.

For example, the amount of cash reported on the balance sheet on Dec. 31 of 2018, 2017, 2016, 2015, and 2014 will be expressed as a percentage of the Dec. 31, 2014, amount. Vertical analysis is used in order to gain a picture of whether performance metrics are improving or deteriorating.

## Vertical Analysis

For example, by showing the various expense line items in the income statement as a percentage of sales, one can see how these are contributing to profit margins and whether profitability is improving over time. It thus becomes easier to compare the profitability of a company with its peers. Common-size financial statements often incorporate comparative financial statements that include columns comparing each line item to a previously reported period. In accounting, vertical analysis is used to analyze financial statements. Each line item in the statements is presented as a percentage of another line item within the same set of statements, thus showing the relative proportion of each account balance.

• These types of financial statements, including detailed vertical analysis, are also known as common-size financial statements and are used by many companies to provide greater detail on a company’s financial position.
• In accounting, vertical analysis is used to analyze financial statements.
• The total revenue is taken as a base item, and other heads of the income statement are presented as a percentage of the base figure.
• For example, the amount of cash reported on the balance sheet on Dec. 31 of 2018, 2017, 2016, 2015, and 2014 will be expressed as a percentage of the Dec. 31, 2014, amount.
• The vertical analysis of the cash flow statement is made by showing each cash outflow and inflow as a percentage of the total cash inflows.
• It is a management tool used by companies in analyzing the changes in the relative size of different accounts over several years.

In a vertical analysis, you would use financial information each year to calculate the relationship of each line item to a base amount. The net sales amount will be shown as 100%, with all other line items shown as a percentage of net sales. Total assets will be shown as 100%, with all other line items shown as a percentage of total assets.

## Horngren’S Financial And Managerial Accounting

Vertical analysis is a method of financial statement analysis in which each line item is listed as a percentage of a base figure within the statement. Vertical analysis refers to the comparative analysis of the financial statement in which each line item is represented as a percentage of the base item. The items on the income statement are presented as a percentage of total revenue, and the items on the balance sheet are presented as a percentage of total assets or total liabilities. The vertical analysis of the cash flow statement is made by showing each cash outflow and inflow as a percentage of the total cash inflows. Vertical analysis is used to show the relative size of each item line of the income statement and the balance sheet. Vertical analysis makes it much easier to compare the financial statements of one company with another, and across industries. This is because one can see the relative proportions of account balances. Financial statements that include vertical analysis clearly show line item percentages in a separate column. These types of financial statements, including detailed vertical analysis, are also known as common-size financial statements and are used by many companies to provide greater detail on a company’s financial position.

## What Is Vertical Analysis?

This shows that the amount of cash at the end of 2018 is 141% of the amount it was at the end of 2014. By doing the same analysis for each item on the balance sheet and income statement, one can see how each item has changed in relationship to the other items. You can easily compare the results from 2015 and 2016 using this type of analysis.

## Vertical Analysis: Definition, How It Works, and Example

In the vertical analysis, though you cannot see that sales have increased, you can see that the gross margin, operating income, and net income have increased as a percentage of sales. This analysis will be used in conjunction with the horizontal analysis, ratio analysis, and others (described in a later lesson) to review the company’s operations. 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.

In fact, some sources of industry data present the information exclusively in a common-size format, and most of the accounting software available today has been engineered to facilitate this type of analysis. Options A, C, and D are incorrect because the sales account is generally used as… If a company has a gross sale amounting to \$5 million in which \$1 million represents the cost of goods sold, \$2 million used for general expenses and a tax rate of 25%. Common-size analysis is also an effective way of comparing two companies with different levels of revenues and assets.