# Vertical Analysis

Vertical analysis is the comparison of financial statements by representing each line item on the statement as a percentage of another (base) line item.

The objective of vertical analysis is to be able to compare financial statements either from different accounting periods, different businesses or to industry averages by restating the information relative to a common base line item. For this reason vertical analysis is also known as vertical common size analysis or simply common size analysis.

The analysis can be carried out on any of the financial statements but is usually performed on the balance sheet and income statement. While the vertical analysis can be performed on each statement in isolation, it is always better to analyse both balance sheet and income statements together to avoid drawing the wrong conclusions about the performance of a business.

## Vertical Analysis Formula

In vertical analysis each line item is calculated as percentage of a common base line item. The vertical analysis formula used to calculate the line item percentages is as follows:

Line item % = Line item amount / Base line item amount

For example, on the income statement, if the base chosen is revenue, then each line item would be expressed as a percentage of revenue. If revenue for the period is 60,000 and sales and marketing expenses are 8,000, then the line item percentage for sales and marketing expenses is given by the vertical analysis formula as follows:

```Revenue (Base) = 60,000
Sales and marketing = 8,000

Line item % = Line item amount / Base line item amount
Line item % = 8,000 / 60,000 = 13.3%
```

## Vertical Analysis of Income Statement

This example shows a vertical analysis of an income statement with the right hand column showing each line item as a percentage of revenue.

Vertical analysis income statement
Amount %
Revenue 60,000 100.0%
Cost of sales 24,000 40.0%
Gross margin 36,000 60.0%
Research and development 5,000 8.3%
Sales and marketing 8,000 13.3%
Operating expenses 25,000 41.7%
Depreciation 2,000 3.3%
Operating income 9,000 15.0%
Finance costs 1,000 1.7%
Income before tax 8,000 13.3%
Income tax expense 1,600 2.7%
Net income 6,400 10.7%

Having carried out the vertical analysis, the next step is to use these common size income statements to make comparisons to the similar statements from different periods, different businesses, or industry averages. This technique is more fully discussed in our common size income statement tutorial.

## Vertical Analysis of Balance Sheet

Vertical analysis can also be carried out on the balance sheet statement. Again the process involves choosing a base line item and then expressing each line item in the balance sheet as a percentage of that base item.

In the example below total assets has been chosen as the base line item and the right hand column shows each line item as a percentage of total assets.

Vertical analysis balance sheet
Amount %
Cash 14,000 6.8%
Accounts receivable 60,000 29.1%
Inventory 2,000 1.0%
Current assets 76,000 36.9%
Long term assets 130,000 63.1%
Total assets 206,000 100.0%
Accounts payable 20,000 9.7%
Other liabilities 25,000 12.1%
Current liabilities 45,000 21.8%
Long-term debt 40,000 19.4%
Total liabilities 85,000 41.3%
Capital 20,000 9.7%
Retained earnings 101,000 40.0%
Total equity 121,000 58.7%
Total liabilities and equity 206,000 100.0%

Again, the next step is to use these vertical analysis common size statements to make comparisons to similar statements from different periods, businesses or industry averages. This technique is more fully discussed in our common size balance sheet tutorial.

## Vertical Analysis of Cash Flow Statement

Finally, vertical analysis can also be carried out on the cash flow statement. In the example below revenue (from the income statement) has been chosen as the base line item and the right hand column shows each line item as a percentage of revenue which, for this example, is assumed to be 120,000.

Vertical analysis cash flow statement
Amount %
Net income 10,000 8.3%
Working capital -5,000 -4.2%
Operating activities 17,000 14.2%
Capital expenditure -30,000 25.0%
Investing activities -30,000 25.0%
Debt repayments -10,000 8.3%
New debt 26,000 21.7%
New capital 12,000 10.0%
Financing activities 28,000 23.3%
Net cash flow 15,000 12.5%
Opening cash balance 1,000 0.8%
Closing cash balance 16,000 13.3%

The above vertical financial statement analysis uses revenue as the base line item, however, other appropriate base line items such as total cash inflow could equally well have been used.

## Vertical and Horizontal Analysis

Vertical analysis in accounting is only one technique which can be used to analyze financial information. As an alternative, horizontal analysis can be carried out where financial statements and accounting ratios are compared over a number of accounting periods in order to spot trends over time.