Analysis Along the Vertical Axis: Explanation, Function, and Illustration
Get the Full Picture with Vertical Analysis
Want to dive deeper into your business's financials? Vertical analysis is the way to go! This financial technique focuses on each line item's contribution to the total, expressed as a percentage. This allows for an easier understanding of the correlation between specific items on a balance sheet or income statement and the bottom line.
What's the 411 on Vertical Analysis?
It's all about comparing apples to apples. Vertical analysis takes a line item and compares it to a specific base figure within the same financial statement, like comparing expenses on an income statement to sales, or assets on a balance sheet to total assets or total liabilities.
Key Takeaways
- Ease of comparison: Vertical analysis helps you compare a company's financial statements to another, and across industries by focusing on relative proportions.
- Time series analysis: Vertical analysis also makes it easier to compare different periods for time series analysis, helping you see if performance metrics are improving or not.
- Profitability insights: By showing expense line items as a percentage of sales, you can see how they're contributing to profit margins and gain insights into a company's profitability.
Vertical Analysis in Action
Let's say XYZ Corporation has gross sales of $5 million, cost of goods sold of $1 million, general and administrative expenses of $2 million, and a 25% tax rate. With vertical analysis, their income statement would look like this:
| Line Item | Percentage of Net Sales ||------------------------------|------------------------|| Sales | 100% || Cost of Goods Sold | 20% || Gross Profit | 80% || General and Administrative Expenses| 40% || Operating Income | 40% || Taxes | 5% || Net Income | 35% |
Vertical Analysis vs. Horizontal Analysis
While vertical analysis looks at numbers in financial statements in the same period and calculates each line as a percentage of the base figure in that section, horizontal analysis compares historical data on a financial statement over different accounting periods. This is where ratios or line items are compared over a certain period of time by choosing one year's worth of entries as a baseline, while every other year represents percentage differences in terms of changes to that baseline.
Pros and Cons of Vertical Analysis
Pros:- It allows for comparison between different accounting periods and different companies.- It provides insights into which metrics are improving and which are worsening.
Cons:- It doesn't take into consideration absolute numbers, so if you are comparing two companies, looking at percentages will give a different result than absolute numbers.
In Conclusion
Vertical analysis helps you understand the composition of your financials, making it easier to identify trends and compare performance. By expressing each line item as a percentage of a specific base figure, you can get a clearer picture of your financial health and efficiency.
- In the realm of cryptocurrency finance, vertical analysis could be utilized to dissect an Initial Coin Offering's (ICO) financial breakdown, assessing each token sale's contribution to the total amassed.
- Within the decentralized finance (Defi) industry, vertical analysis could offer a valuable perspective, shedding light on the proportional significance of various investments within a Defi business's portfolio.
- When an investor is selecting various businesses to support, vertical analysis can serve as a useful tool to compare the financial efficiency of different ventures, examining the proportion of total revenue spent on business expenses such as salaries, marketing, or research and development.
