can someone please help me understand how to perform vertical analysis
Of course! I'd be happy to help you understand how to perform vertical analysis.
Vertical analysis is a technique used in financial statement analysis to compare the relative proportions or percentages of different line items within a single financial statement. It helps to analyze the vertical structure of a company's financial statements, providing insights into the relative importance of each item.
To perform vertical analysis, follow these steps:
1. Choose the financial statement: Decide which financial statement you want to analyze vertically. The most common choice is the income statement or the balance sheet.
2. Identify the base amount: Select a base amount to which all other line items will be compared. For the income statement, the base amount is usually total revenue or net sales. For the balance sheet, the base amount is typically total assets or total liabilities and equity.
3. Express each line item as a percentage of the base amount: Calculate the percentage of each line item in relation to the base amount. Divide each line item by the base amount and multiply by 100 to express it as a percentage.
4. Interpret the results: Analyze the vertical analysis results to identify any significant trends or patterns. Look for items that have increased or decreased significantly in proportion to the base amount. Pay attention to any outliers or anomalies in the percentages.
Here's a simplified example to illustrate the process:
Let's say you want to perform vertical analysis on an income statement with total revenue as the base amount. You have the following line items:
- Sales: $500,000
- Cost of Goods Sold: $200,000
- Gross Profit: $300,000
- Operating Expenses: $150,000
- Net Income: $150,000
To calculate the vertical analysis, divide each line item by the base amount (total revenue) and multiply by 100:
- Sales: ($500,000 / $500,000) * 100 = 100%
- Cost of Goods Sold: ($200,000 / $500,000) * 100 = 40%
- Gross Profit: ($300,000 / $500,000) * 100 = 60%
- Operating Expenses: ($150,000 / $500,000) * 100 = 30%
- Net Income: ($150,000 / $500,000) * 100 = 30%
In this example, you can observe that gross profit represents 60% of total revenue, while net income and operating expenses both account for 30% each. This provides a clear picture of the relative proportions of different items on the income statement.
Remember, vertical analysis is a useful tool to compare the composition of different line items within a financial statement and identify any noteworthy trends or changes.