How to Prepare a Vertical Analysis
Vertical analysis, also known as common-size analysis, is a financial analysis technique that involves expressing each item on a financial statement as a percentage of a base figure. This base figure can be total assets, total liabilities, total equity, or net sales, depending on the type of financial statement being analyzed. Vertical analysis is a valuable tool for understanding the composition and structure of a company’s financial statements. In this article, we will discuss how to prepare a vertical analysis step by step.
Step 1: Gather Financial Statements
The first step in preparing a vertical analysis is to gather the financial statements you want to analyze. This typically includes the income statement, balance sheet, and cash flow statement. Ensure that you have the most recent financial statements available, as older data may not be reflective of the current financial situation of the company.
Step 2: Determine the Base Figure
Once you have the financial statements, determine the base figure for your vertical analysis. For the income statement, the base figure is usually net sales. For the balance sheet, it can be total assets, total liabilities, or total equity. For the cash flow statement, the base figure is often net cash flow from operating activities.
Step 3: Calculate the Percentage for Each Item
For each item on the financial statement, calculate the percentage it represents relative to the base figure. To do this, divide the item’s value by the base figure and multiply by 100. For example, if a company has net sales of $1,000,000 and cost of goods sold is $500,000, the cost of goods sold as a percentage of net sales would be (500,000 / 1,000,000) 100 = 50%.
Step 4: Create the Vertical Analysis Table
After calculating the percentages for each item, create a vertical analysis table. This table should have two columns: one for the item’s name and one for its percentage. List all the items on the financial statement in the order they appear, and fill in the corresponding percentages in the second column.
Step 5: Analyze the Results
Once you have completed the vertical analysis table, analyze the results. Look for trends, such as increasing or decreasing percentages over time, and identify any areas of concern. For example, if the cost of goods sold percentage is increasing, it may indicate that the company is experiencing higher production costs.
Step 6: Compare with Industry Benchmarks
To gain a better understanding of your company’s financial performance, compare the vertical analysis results with industry benchmarks. This will help you determine whether your company is performing better or worse than its competitors.
In conclusion, preparing a vertical analysis is a straightforward process that involves gathering financial statements, determining the base figure, calculating the percentage for each item, creating a vertical analysis table, analyzing the results, and comparing with industry benchmarks. By following these steps, you can gain valuable insights into your company’s financial health and make informed decisions.
