Vertical Analysis
The process of converting separate data into percentages on a common foundation
Vertical analysis is the process of converting separate data into percentages on a common foundation. The percentage of each component illustrates how it relates to the overall.
It is a sort of analysis in which each accounting variable is examined vertically. This type of statement is also called Common Size Statements. They may be prepared for the balance sheet as well as the profit and loss statement.
Financial statements show the absolute values of an organization's assets, liabilities, revenues, costs, and profit or loss. However, they do not directly offer the company's earning capability, liquidity, or financial stability, which makes them difficult for users to read.
As a result, financial statements are thoroughly evaluated to display them clearly and intelligibly. The following are various accounting tools used to analyze these financial statements:
Comparative Statements or Horizontal Analysis
Common Size Statements or Vertical Analysis
Break-Even Point Analysis
In this article, we will discuss vertical analysis.
It is a proportional evaluation of a financial statement in which each line item is given as a percentage of another line item.
It comprises the following:
Absolute amounts of specific items on the Statement of Profit and Loss and the Balance Sheet for two or more successful periods are expressed as a percentage of a common base.
Typically, the total revenue from operations is used as a base for the Statement of Profit and Loss, and the total of assets or equity & liabilities is used as a foundation for the Balance Sheet items.
This implies that each line item is expressed as a percentage of gross sales on an income statement, but on a balance sheet, each line item is expressed as a percentage of total assets.
Purpose of Vertical Analysis
1. Establish a relationship
As various items on the balance sheet (or the income statement) are expressed as a percentage of the total of the balance sheet (or the revenue from operations), over time, a relationship gets established between them. This helps in drawing significant conclusions.
For example, over the years, it has been established that the cost of raw materials for an organization is 35-40% of the revenue from operations; an increase in this percentage range will need immediate attention.
2. Providing a common base for comparison
The key benefit of vertical financial statement analysis is that it allows you to compare income statements and balance sheets from organizations of various sizes.
Financial statements of different organizations, when expressed as a percentage to a common base, makes them easier to compare them irrespective of their sizes.
Comparing the exact numbers of organizations of various sizes does not yield helpful information about their financial position.
3. Identify trends
The information gathered from a vertical analysis of the financial statements can be used to compare specific accounting periods, making it easier to identify trends in the accounting books and any increase or fall that may have occurred over time.
4. Aid in decision-making
It may also be used to discover business processes with unusually high costs or returns and then utilize that information to make judgments regarding your company's future course.
Lastly, a company's aims and objectives will determine how vertical analysis is applied to the books of accounts.
Preparation of Common Size Balance Sheet
A common-size balance sheet is also a balance sheet containing figures from two (or more) accounting periods to which the vertical analysis has been applied. It consists of five columns.
Column 1: Items of Balance Sheet
Column 2: Amounts of different items of assets and equities & liabilities on the current year's balance sheet.
Column 3: Amounts of different items of assets and equities & liabilities on the previous year's balance sheet or from another year to be compared.
Column 4: The percentage of different items of assets and, equities & liabilities on the current year's balance sheet to the same year's total assets or liabilities, which is taken as 100.
Column 5: The percentage of different items of assets and equities & liabilities on the previous year's balance sheet to that year's total assets or liabilities, which is taken as 100.
Common Size Balance Sheet
As at _________________________
Absolute Amounts ($)
Percentage of Balance Sheet Total (%)
Current Year Previous Year Current Year Previous Year
I. ASSETS:
i) Non-Current Assets xx xx x x
ii) Current Assets xx xx x x
Total Assets xxx xxx 100 100
II. LIABILITIES & OWNER'S EQUITY:
i) Non-Current Liabilities xx xx x x
ii) Current Liabilities xx xx x x
Owner's Equity
i) Share Capital xx xx x x
ii) Reserve & Surplus xx xx x x
Total Liabilities & Owner's Equity xxx xxx 100 100
Below are the balance sheets of X Ltd and Y Ltd as of 31st December 2021. Apply vertical analysis and comment on their financial positions.
Balance Sheet of X Ltd. and Y Ltd.
As of 31st December 2021
X ltd. Y ltd. X ltd. Y ltd.
i) Non-Current Assets
250,000 300,000 41.67 40
150,000 100,000 25 13.33
ii) Current Assets 200,000 350,000 33.33 46.67
Total Assets 600,000 750,000 100 100
i) Non-Current Liabilities 200,000 300,000 33.33 40
ii) Current Liabilities 100,000 50,000 16.67 6.67
i) Shareholder's Funds 300,000 400,000 50 53.33
Total Liabilities & Owner's Equity 600,000 750,000 100 100
Comments: Based on the above common-size balance sheet of X Ltd. and Y Ltd., the following differences can be observed in their financial positions:
1. The short-term financial position of Y Ltd. is better when compared to X Ltd. The current liabilities of Y Ltd. are 6.67% of the total funds invested, whereas the proportion of current assets in these firms is 46.67%.
On the other hand, the current liabilities of X Ltd. are 16.67% of total funds, while the current assets are 33.33% of these funds. Thus, trade payables are more secured in Y Ltd.
2. Like the short-term financial position, the financial position in the long term of Y Ltd. is also better when compared to X Ltd.
The shareholder's funds, as seen in the common-size balance sheet, are 53.33% of total funds for Y Ltd. whereas, in the case of X Ltd. is 50% only.
3. Non-current liabilities, X Ltd. and Y Ltd (33.33% and 40%, respectively), are less than the shareholder's funds (50% and 53.33%, respectively).
It shows that both firms have sufficient protection from long-term lenders.
4. Investment in non-current assets can be seen more in X Ltd. (66.67%) as compared to Y Ltd (53.33%).
Preparation of Common Size Statement of Profit & Loss
A common-size statement of profit & loss is a statement in which the figure revenue from operations is taken as the common base, and all other items in the statement are expressed as a percentage. It is a vertical analysis applied statement of profit & loss.
It also has five columns.
Column 1: Items of Statement of Profit & Loss.
Column 2: Amounts of different items, i.e., income or expenses on the statement of profit & loss of the current year.
Column 3: Amounts of different items, i.e., income or expenses on the statement of profit & loss of the previous year or from another year to be compared.
Column 4: The percentage of different items of the statement of profit & loss of the current year to the same year's revenue from operations is taken as 100.
Column 5: The percentage of different items of the statement of profit & loss of the previous year to that year's revenue from operations is taken as 100.
Common Size Statement of Profit & Loss
For the year ended on ___________________________
I. Revenue from Operations
xxx xxx 100 100
II. Add: Other Incomes
xx xx x x
III. Total Revenue (I+II)
IV. Less: Expenses:
Cost of Materials Consumed xx xx x x
Purchase of Stock xx xx x x
Changes in Inventory of
Work-in-Progress
Depreciation xx xx x x
Other Expenses xx xx x x
Total Expenses xxx xxx xx xx
V. Profit before Tax (III-IV)
xxx xxx x x
VI. Less: Tax
(xx) (xx) (x) (x)
VII. Profit after Tax (V - VI)
Apply vertical analysis of the given Statement of Profit & Loss of ABC Ltd. and interpret the same.
ABC Ltd.
Statement of Profit & Loss
For the year ended on 31st December 2021, and 31st December 2020
Common-Size Statement of Profit & Loss
31st December 2021 31st December 2020 31st December 2021 31st December 2020
2,500,000 2,000,000 100 100
Cost of Materials Consumed 1,700,000 1,400,000 68 70
Finance Cost 200,000 160,000 8 8
Other Expenses 100,000 140,000 4 7
Total Expenses 2,000,000 1,700,000 80 85
V. Profit before Tax(III-IV)
600,000 400,000 24 20
VI. Tax @ 40%
240,000 160,000 9.6 8
VII. Profit after Tax
360,000 240,000 14.4 12
Interpretation: The above analysis reveals the following:
The cost of materials consumed has reduced by 2% in the year ending on 31st December 2021 due to a reduction in the cost of raw materials.
Total expenses have decreased from 85% to 80% in the year ending 31st December 2021. As a result, profit before tax has increased from 20% to 24%, and profit after tax increased from 12% to 14.4% in 2021.
It may be concluded that the company worked more efficiently in 2021 compared to 2020.
This type of statement is also called Common Size Statements.
A common-size balance sheet is also a balance sheet containing figures from two (or more) accounting periods to which the vertical analysis has been applied.
It can be used for the following:
To establish a relationship and draw significant conclusions.
To provide a common base for comparison.
To identify trends.
To aid in the decision-making process of the organization.
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Researched and authored by Aqsa Wasif | LinkedIn