Question

How would you do vertical analysis of an income statement? Of a balance sheet? Provide a specific example as part of you explanation.

Answer 1

Vertical analysis is a method of financial statement analysis in which each line item is shown as a percentage of the base figure.

In Income statement, each line item is shown as a percentage of net sales (i.e. revenue from operations). In Balance sheet, each item is shown as a percentage of total assets or total liabilities.

The benefit of vertical analysis is that one can see the relative proportion of balances of accounts in comparison to the base figure. It helps to gain a picture of whether the performance is improving or getting worse.

The example is as follows:

Common-size Income Statement
	Amount	Percentage
Revenue
Service renenue	$ 125,000.00	100.00%
Total revenue	$ 125,000.00	100.00%
Expenses
Advertising	$   19,000.00	15.20%
Dividends	$   15,000.00	12.00%
Depreciation	$   11,000.00	8.80%
Insurance	$     3,500.00	2.80%
Rent	$   18,000.00	14.40%
Salaries	$   30,000.00	24.00%
Supplies	$     5,500.00	4.40%
Total expenses	$ 102,000.00	81.60%
Net Income	$   23,000.00	18.40%

It can be clearly seen that the total expenses are 81.60% of total revenue and profit is 18.40% of the total revenue. In this way, other relations can also be established.

The another example is as follows:

Balance Sheet
Assets	Amount	Percentage
Non-current assets
Patents	$   20,000.00	7.78%
Equipments	$ 204,000.00	79.38%
Total Non-current assets	$ 224,000.00	87.16%
Short term assets
Cash and cash equivalents	$   16,000.00	6.23%
Accounts receivables	$     9,000.00	3.50%
Inventory/Supplies	$     3,000.00	1.17%
Prepaid Insurance	$     5,000.00	1.95%
Total Current assets	$   33,000.00	12.84%
Total Assets	$ 257,000.00	100.00%
Liabilities
Non-current liabilities
Long term debt/Notes payable	$   80,000.00	31.13%
Total Non-current liabilities	$   80,000.00	31.13%
Current Liabilities
Accounts payable	$   22,000.00	8.56%
Wages payable	$   15,000.00	5.84%
Total current liabilities	$   37,000.00	14.40%
Total Liabilities	$ 117,000.00	45.53%
Common stock	$   55,000.00	21.40%
Retained earnings	$   85,000.00	33.07%
Total Shareholders' funds	$ 140,000.00	54.47%
Total liabilities and shareholders funds	$ 257,000.00	100.00%

It can be clearly seen that the total non-current assets are 87.16% of the total assets. In this way, other relations can also be established.

In case of any doubt, please comment.