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What is 'Vertical Analysis'

Vertical analysis is a method of financial statement analysis in which each entry for each of the three major categories of accounts, or assets, liabilities and equities, in a balance sheet is represented as a proportion of the total account. Vertical analysis is also used across other financial statements as a percentage measure.

BREAKING DOWN 'Vertical Analysis'

The main advantage of vertical analysis is the balance sheets, income statements and other financial reports of businesses of all sizes can easily be compared. It also makes it easy to see relative annual changes within one business.

Vertical analysis reports each line item of a financial statement as a representation of the percentage of the statement's main focus. For an income statement, each line item can be representative of gross sales. On the balance sheet, each line item can be representative of total assets. In a cash flow statement, each line item can be expressed as a percentage of the firm’s total cash and cash equivalents.

Vertical analysis allows for a company’s financial statement to be represented within a standard process across all industries. A snapshot can be taken of a company’s financial position by line item. It also allows for easy comparison to previous periods for timeline analysis, including annual quarter and sequential quarter analysis, and analysis of longer time periods such as five years or three years.

Financial statements including 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. Often, common-size financial statements also incorporate comparative financial statements that include columns comparing each line item to a previously measured period.

Vertical Analysis Example

For example, suppose XYZ Corporation has three assets: cash and cash equivalents worth $3 million, inventory worth $8 million and property worth $9 million. If vertical analysis is used, the asset column looks like:

Cash and cash equivalents: 15%

Inventory: 40%

Property: 45%

If comparative financial statements are also used, then additional detail from previous periods is also included and an additional comparative column for the percentages of a previous period is added.

The method of vertical analysis can also be contrasted with horizontal analysis, which uses one year's worth of entries as a baseline while every other year represents percentage differences in terms of changes to that baseline.

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