Vertical analysis, also known as common-size analysis, is a financial statement analysis technique that reports each of a company’s financial statement items as a percentage of a common base figure. By expressing each item as a percentage or a ratio, it makes it easier to identify and compare company trends over time.

In this article, I’ll explain what vertical analysis is, how it works, and how to interpret the results.

What is Vertical Analysis?

Vertical analysis is a method of financial statement analysis in which each line item on a financial statement is listed as a percentage of another item. For example, on an income statement, every line item is stated in terms of the percentage of gross sales. Similarly, on a balance sheet, every entry is made not in terms of absolute currency but as a percentage of the total assets or total liabilities. Performing a vertical analysis of a company’s cash flow statement represents every cash outflow or inflow relative to its total cash inflows.

The main purpose of vertical analysis is to show the relative proportions of different line items within a financial statement, and how they change over time. This can help to assess the financial performance, profitability, liquidity, solvency, and efficiency of a company.

How to Perform Vertical Analysis

To perform vertical analysis, you need to follow these steps:

1. Choose a base figure for each financial statement. For example, for the income statement, you can use gross sales or net sales; for the balance sheet, you can use total assets or total liabilities; for the cash flow statement, you can use total cash inflows or net cash flows.
2. Divide each line item by the base figure and multiply by 100 to get the percentage. For example, if gross sales are $100,000 and cost of goods sold are $60,000, then the percentage of cost of goods sold is ($60,000 / $100,000) x 100 = 60%.
3. Repeat the process for each line item and for each period. For example, if you want to compare the income statements of two years, you need to calculate the percentages for each line item for both years.
4. Prepare a common-size financial statement that shows the percentages for each line item and each period. For example, you can use a table like this:

Income Statement	2023	2024
Gross Sales	100%	100%
Cost of Goods Sold	60%	55%
Gross Profit	40%	45%
Operating Expenses	25%	20%
Operating Income	15%	25%
Interest Expense	5%	4%
Income Before Taxes	10%	21%
Income Tax Expense	3%	6%
Net Income	7%	15%

How to Interpret the Results

To interpret the results of vertical analysis, you need to look at the changes in the percentages over time and compare them with the industry averages or benchmarks. For example, from the table above, you can see that:

• The company’s gross profit margin increased from 40% to 45%, which means that the company improved its efficiency in producing and selling its products.
• The company’s operating income margin increased from 15% to 25%, which means that the company reduced its operating expenses and increased its profitability.
• The company’s net income margin increased from 7% to 15%, which means that the company increased its bottom line and generated more earnings for its shareholders.
• The company’s interest expense decreased from 5% to 4%, which means that the company reduced its debt burden and paid less interest on its borrowings.

These are positive signs that indicate that the company performed well in the two years. However, to get a more complete picture, you need to compare these percentages with the industry averages or benchmarks, and see how the company stands against its competitors. For example, if the industry average for gross profit margin is 50%, then the company still has room for improvement.

Conclusion

Vertical analysis is a useful technique for financial statement analysis, as it shows the relative proportions of different line items within a financial statement, and how they change over time. It can help to assess the financial performance, profitability, liquidity, solvency, and efficiency of a company. However, vertical analysis should be used in conjunction with other methods of financial analysis, such as horizontal analysis, ratio analysis, and trend analysis, to get a more comprehensive and accurate view of a company’s financial health.