The most common methods for assessing the financial situation are vertical and horizontal analysis of the financial statements. These methods allow you to increase the company’s revenues, reduce risks and prevent possible negative consequences from improper accounting, reporting, and management decisions.
As you know, vertical means up and down. The vertical analysis compares all items up and down in a column. In other words, it compares each item with the base value, which is presented as 100%. Accordingly, the sum of all items as a percentage is also equal to 100%. Financials in this form are also called common-size financial reports. Unlike the horizontal, you only need to look at one year to calculate the vertical analysis.
This type of analysis can provide valuable information. For instance, knowing the percentage of the cost of goods sold in the sales amount can help to determine whether you are making a profit off the product you are selling before any expenses are taken into consideration. You can also look at the previous year of your own company to see if any areas have increased or decreased and if there is a problem or not.
If you were to compare the two different years using the vertical analysis percentage, you can see what changes have been made and whether or not they were beneficial for the business. If a percentage of an expense, for instance, was very high, it could be a sign that the company is not using their resources efficiently and should investigate how they can lower that cost.
The Balance sheet is the main report of the organization, revealing the essence of its economic condition. Vertical analysis of this accounting report is based on the calculation of the percentage of individual Balance sheet items in relation to the total value of its assets (liabilities) by dividing the asset (liability) items by their total value in the financial statement for that year.
This allows one to identify the specific weight of each item in the final results and make an analysis of the stability of the financial condition of the enterprise at the time of reporting, as well as assess its dynamics. Vertical analysis shows the structure of enterprise funds and their sources.
During a certain period of activity of the enterprise, the various business activities form the financial results of the business operations. The sale of goods or services and other activities aimed at obtaining other income as well as certain expenses that arise as a result of these activities form the Profit and loss statement, the bottom line of which may be profit or loss.
If the income exceeds the expenses, then the organization made a profit in the reporting period. If expenses exceed income, then the organization received a loss in the reporting period. Vertical analysis of income provides for the determination of the share of each item in the final profit (loss) indicator.
To determine the specific weight of each item a baseline category is determined. For instance, you can use Sales value as your 100% base number. There may be several baselines, for example, you can calculate:
- the share of each item in the net profit indicator;
- the proportion of revenue and COGS in relation to the gross profit indicator;
- the share of expenses and revenue items in relation to the indicator of profit before tax, etc.
The profit and loss statement’s vertical analysis helps to determine how each item of income and expense affected the size of the profit.