Using the Vertical Method to Analyze Financial Statements

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  • 0:00 What Is Vertical Analysis?
  • 0:47 Balance Sheets &…
  • 2:11 Income Statements &…
  • 3:52 Lesson Summary
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Lesson Transcript
Instructor: Beth Loy

Dr. Loy has a Ph.D. in Resource Economics; master's degrees in economics, human resources, and safety; and has taught masters and doctorate level courses in statistics, research methods, economics, and management.

This lesson focuses on vertical analysis, which is used to compare items in the same financial statement. After this lesson, you'll be able to explain how to use the analysis for a balance sheet and income statement.

What Is a Vertical Analysis?

Say you are buying a car and you want to see exactly where your money is going. How much goes to the audio system and heated seats? What about the wheels? And you can't forget about the engine, sunroof, and interior. Well, if you've looked at what percentage the sunroof costs compared to the entire car, you have experience with vertical analysis, the vertical method of analyzing financial statements.

Vertical analysis occurs when an accountant compares different aspects of a financial statement in terms of a percentage of the total amount. The owner of the dealership where you bought your car likely uses vertical analysis on the company's balance sheet and income statement. Let's look at examples of each.

Balance Sheets & Vertical Analysis

Balance sheets show all the assets, liabilities, and equity of a company at a particular time. When doing a vertical analysis, each of the line items on a balance sheet is usually shown as a percentage of total assets.

For example, say our car dealership is worth $10 million in total assets, including $5 million dollars in cash, $1 million dollars in inventory, and $4 million dollars in accounts receivable. The dealership also has $3 million dollars in liabilities and $7 million dollars in equity. Based on this information:

The vertical analysis of total assets is:

Cash: 50% ($5 million dollars/$10 million dollars)

Inventory: 10% ($1 million dollars/$10 million dollars)

Accounts receivable: 40% ($4 million dollars/$10 million dollars)

The vertical analysis of total liabilities and equity is:

Total liabilities: 30% ($3 million dollars/$10 million dollars)

Total equity: 70% ($7 million dollars/$10 million dollars)

This vertical analysis would be important to our car dealership's investors, and it would help us decide whether we need to make changes to how we manage inventory and accounts receivable, pay down loans, invest cash, and balance equity.

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