Vertical Analysis

Vertical analysis restates every line item on a single period’s financial statement as a percentage of one base figure taken from that same statement. On an income statement the base is total revenue, or net sales. On a balance sheet it is total assets. Stating the lines as proportions instead of amounts lets statements of different sizes, and the same statement in different periods, be compared on shape rather than on size. The same technique is also called common-size analysis, and a statement presented that way is a common-size statement.

The Formula and the Two Base Figures

One division, repeated down the column.

Vertical analysis percentage = (line item / base figure) x 100

Income statement base figure = total revenue, or net sales
Balance sheet base figure    = total assets

The base figure is the one input the technique needs, and each statement supplies its own. An income statement takes its top line, because every cost and every subtotal below it is a claim on that same period’s sales. A balance sheet takes total assets, because that is the total the statement itself balances to, while the income statement carries no equivalent internal total, a difference worked through in balance sheet vs income statement. Reading one balance sheet at one date as a proportion of total assets is structurally the same move debt to asset ratio analysis makes on the liability side.

A Worked Common-Size Income Statement

Say a client’s books close a year on the amounts below. The lines run down the multi-step ladder, gross profit first and then operating income, whose order and content are set out in multi-step income statement.

Common-size income statement, one year

                                     Amount    Percent of net sales
Net sales                           800,000                  100.0%
Cost of goods sold                  480,000                   60.0%
Gross profit                        320,000                   40.0%
Operating expenses                  240,000                   30.0%
Operating income                     80,000                   10.0%
Interest expense                     16,000                    2.0%
Income before income tax expense     64,000                    8.0%
Income tax expense                   14,000                   1.75%
Net income                           50,000                    6.25%

The right-hand column is the client’s margin set, read in one pass. Gross profit’s share of net sales is the gross margin, covered in gross profit; operating income’s share is operating margin; net income’s share is net profit margin. Each of those entries carries what its margin does and does not settle.

One margin never appears in that column. The contribution margin ratio requires costs sorted into variable and fixed, and the statement above groups them by function, cost of goods sold and then operating expenses, so the split it needs is not on the page.

Where the Common-Size Statement Lands in a Firm’s Work

In audit work it is typically a working paper rather than a presentation. Under generally accepted auditing standards, analytical procedures are evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data, and they also encompass such investigation, as is necessary, of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount (AICPA, AU-C 520, paragraph .04).

The standard names the exact comparison a common-size column makes easy. Analytical procedures include comparing the entity’s gross margin percentages with industry averages, or with other entities of comparable size in the same industry (AICPA, AU-C 520, paragraph .A2).

The standard also says which of those relationships tend to be the more predictable. Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts, because income statement accounts represent transactions over a period of time while balance sheet accounts represent amounts as of a point in time (AICPA, AU-C 520, paragraph .A10).

In close and compliance work the same column arrives earlier. Once a period’s trial balance is adjusted, dividing each revenue and expense line by net sales hands the preparer the client’s whole margin set before any ratio schedule is built.

Vertical Analysis Versus Horizontal Analysis

The two techniques read the same statements in different directions. Vertical analysis reads down one period’s statement and states each line against a base figure inside that same period. Horizontal analysis, also called trend analysis, reads across periods and states the change in one line item from one period to the next, in dollars or as a percentage of the earlier period.

So vertical tells you what the period’s shape is, and horizontal tells you what moved. They answer different questions off the same file, and neither substitutes for the other.

What Vertical Analysis Is Not

Vertical analysis is not a decomposition. DuPont analysis breaks one ratio into factors that multiply back to it, while vertical analysis restates every line against a common base.

Common Questions

Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a trial task lets a firm’s own reviewer grade a real block of its close and analysis work before any client file depends on it.