What is vertical statement analysis?

Vertical statement analysis is a financial statements analysis tool that is used to establish a correlation between the base item and every line item in the financial statements. In vertical statement analysis, each line item in financial statements is reflected as a percentage of the base item. In the income statement, each line item is represented as a percentage of the gross turnover because gross turnover is considered as a base figure in income statement analysis. In the balance sheet, each line item is reflected as a percentage of total assets or liabilities.

Purpose of vertical statement analysis

Vertical statement analysis is used in financial statements for a single accounting period. It expresses a proportionate percentage of each line item in the balance sheet and income statement based on the base item. It helps in establishing the correlation between the items in financial statements and how the change in one item affects another. Vertical statement analysis helps users of the financial statements to understand the changes of every line item in the balance sheet, income statement, and cash flow statement. Vertical analysis is widely used to compare the financial statement with prior period statements. Vertical financial statement analysis is also used to compare the financial statements with another company in the same industry.

Vertical analysis of income statement

Vertical analysis is used in the income statements to determine the correlation of income, expenses, and net profit based on the turnover figure. Vertical analysis of the income statement is calculated by dividing the value of the line item by the value of the base item.

For example, if the gross sales of entity A are \$25,000, administration expense is \$3,000 and net income is \$1,200. Vertical analysis of administration expenses will be

$\frac{3,000}{25,000}×100=12%$

And vertical analysis of net income will be

$\frac{1,200}{25,000}×100=4.8%$

Here, vertical analysis of turnover is considered as 100%. Other particulars are computed based on the turnover.

Performa for vertical statement analysis of income statement

This table represents the proforma for vertical statement analysis under the income statement.

 Account titles 2014 2015 Amount Vertical analysis % Amount Vertical analysis % Sales revenue \$75,000 100% \$86,000 100% Cost of goods sold \$27,000 36% \$34,400 40% Gross profit \$48,000 64% \$51,600 60% Salaries expense \$18,000 24% \$19,200 22.3% Rent expense \$12,000 16% \$12,000 14% Office expense \$3,000 4% \$2,800 3.3% Electricity expense \$3,600 4.8% \$4,000 4.6% Other expense \$1,200 1.6% \$1,000 1.2% Net profit \$10,200 13.6% \$12,600 14.6%

(The figures and years mentioned are based on assumptions).

Vertical analysis of balance sheet

Vertical statement analysis in the balance sheet is used to identify the proportion of every line item of the balance sheet depending on the base item. In balance sheet vertical analysis, total assets balance is considered as the base item, and the percentage of every line item is calculated using the base item.

For example, if the total asset value is \$30,000, value of inventory is \$2,500, and value of property is \$12,000. Vertical analysis of inventories will be,

$\frac{2,100}{30,000}×100=7%$

Vertical analysis of the property will be,

$\frac{12,000}{30,000}×100=40%$

Performa for vertical statement analysis of balance sheet

This table represents the proforma for vertical statement analysis of the balance sheet.

 Account titles 2014 2015 Amount Vertical analysis % Amount Vertical analysis % Property, plant, and machinery \$15,000 30% \$24,000 37.3% Building \$20,000 40% \$20,000 31.1% Accounts receivable \$7,000 14% \$12,000 18.6% Inventories \$8,000 16% \$8,400 13% Total asset \$50,000 100% \$64,400 100%

Advantages of vertical analysis of financial statements

The following are the advantages of vertical statement analysis:

Easy execution

Vertical statement analysis is easy to implement. It is an easy and simple method of financial statement analysis. It is easy to understand as it reflects the percentage of every line item as compared to the base item in financial statements.

Comparison with prior years

Vertical financial statement analysis helps the management to compare the items of the financial statements with previous year percentages. It helps to compare the profit, expenses, assets, and liabilities with the prior period. With vertical statement analysis, the entity can identify the efficiency of the entity during the current year as compared to prior years. Comparison with previous periods helps the firm to decide where to allocate resources, where to concentrate more, and the performance of the entity.

Comparison with different size companies

Vertical statement analysis is used in comparing companies of different sizes. It is an effective method to compare the ratios and trends of the entity with different size companies in the same industry. Comparing operations of the entity with different size companies in the same industry helps to improve the profitability and activities of the entity.

The following are the disadvantages of vertical statement analysis:

Does not help to make business decisions

Vertical statement analysis is not helpful in making business decisions as the business decisions involve various ratio analyses. While making business decisions, the entity should analyze the leverage ratios, profitability ratios, debt-equity ratios, and current ratios. Vertical statement analysis gives the correlation between all line items and the base item. It does not help the firm to analyze the ratios.

Liquidity cannot be identified

The liquidity of the entity can be calculated using the liquidity ratio. Vertical statement analysis does not determine ratios, so the liquidity of the entity cannot be determined using vertical statement analysis.

Vertical statement analysis versus horizontal analysis

Horizontal analysis is used for comparing every unit or department of the entity over a period of time. It helps to compare the performance of the organization with prior periods. Horizontal analysis helps the entity to follow the ratios and industry trends. Horizontal analysis is used to compare the ratios and values of the financial statements with previous years.

While vertical analysis is used to identify the proportionate percentage of every line item of the financial statements. It compares every line item of the financial statements with the base item in the financial statements.

Context and Applications

This topic is significant in general studies, professional exams, and also for both undergraduate courses and postgraduate courses and competitive exams, especially for

• Bachelors of Commerce
• Masters of Commerce

Practical Problems

Question 1: Vertical analysis expresses every line item in financial statements based on base figure in terms of __________________.

1. Percentage
2. Ratio
3. Horizontal analysis

Explanation: In vertical statement analysis, each line item in financial statements is reflected as a percentage of the base item. Vertical analysis is a method of establishing the correlation between every line item in financial statements and the base item of financial statements.

Question 2: Gross sales value is \$50,000, salaries and wages are \$7,500. What is the vertical analysis of salaries and wages?

1. 7.5%
2. 1.5%
3. 15%

Explanation: Vertical analysis of salaries and wages is 15%. While calculating vertical analysis of income statement, percentage of gross sales should be considered as a base item. Based on the sales figure vertical analysis is calculated for other line items in the income statement.

Question 3: Accounts receivable is \$12,000 and total assets value in the balance sheet is \$75,000. What is the vertical analysis of accounts receivables?

1. 1.6%
2. 16%
3. 16

Explanation: Vertical analysis of accounts receivables is 16%. While calculating the vertical analysis of the balance sheet, the percentage of total assets should be considered as a base figure. Based on the value of the total assets vertical analysis is calculated for other line items in the balance sheet.

Question 4: What are the disadvantages of vertical statement analysis?

1. Liquidity cannot be identified
2. Does not help to make business decisions
3. All of the above

Explanation: Vertical statement does not help to make business decisions. Because while making business decisions entity should perform various ratio analyses. Liquidity cannot be determined using vertical statement analysis. These are considered as disadvantages of the vertical statement analysis.

Question 5: What are the advantages of vertical statement analysis?

1. Easy execution
2. Compare the financial statements with prior period financials
3. All of the above

Explanation: Vertical statement analysis is easy to implement and easy to understand. It is used to compare the financial statements with previous year statements and compare the financial statements with different size companies in the same industry.

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