Vertical analysis is a way of analyzing financial statements that focuses on the individual line items and their relationships to each other, as opposed to Horizontal analysis, which looks at aggregate figures. It is often used in conjunction with Horizontal Analysis.
Vertical analysis vs. Horizontal analysis
Vertical analysis can be done using many ratios, including Current Ratio, Quick Ratio, Gross Margin Percentage, etc. It can also be done using vertical modeling or forecasting techniques like linear regression or exponentially smoothed averages. Vertical analysis is one of the most common ways to compare a company's performance from period to period. Thus, it serves as a helpful check against other types of analysis, such as horizontal analysis, where changes might not actually indicate a real problem unless they are sizable enough.
In contrast with Horizontal Analysis, Vertical analysis often involves financial ratio analysis and common-size statements. Common size statements display each item as a percentage of some base, such as sales or total assets. These represent the same data in two different ways: horizontally and vertically. Horizontal statements are more popular because they are easier to read.
Uses of vertical analysis:
· Vertical analysis is used to identify patterns within company data that can then forecast future performance. By looking at historical trends, it's possible to see if specific numbers have increased over time, decreased over time, or fluctuated due to random happenings. By spotting these trends, it's possible to forecast what might happen in the future based on performance in previous periods. The vertical analysis allows the analyst to find patterns within companies, thus creating predictions for future performance.
· Vertical analysis can be used in conjunction with Horizontal Analysis. However, the two types of analysis are not mutually exclusive, and each has its own purpose. For example, horizontal analysis shows changes over time across many different areas of financial statements. In contrast, Vertical Analysis focuses on individual line items within the statement itself, or how those items move relative to one another.
· Vertical analysis can be helpful because it indicates what is driving the change observed in the horizontal statements (which may themselves require further vertical analysis). For example, if inventory increased by $10 million but sales remained constant, then this implies that additional inventory must have been purchased or that inventory was reduced. If inventory was reduced, then it's possible that the company made use of excess inventories, which could be bad for future performance if those inventories are needed.
· Vertical analysis can determine ways to improve existing processes by analyzing what is occurring within the process and finding ways to change it to make it better. Often, an improvement can be made simply by creating a small tweak to an existing process rather than changing the entire system itself. Vertical analysis is helpful in this regard because it allows analysts to find problems with much less effort than would typically be required using other types of analysis, such as Horizontal Analysis, where one would have to check many individual variables before identifying a problem.
· A company's performance can be analyzed using vertical analysis through the use of common size statements and ratios. Common size statements display each item as a percentage of some base, such as sales or total assets. Ratio analysis is used to determine how well the items affected by different variables perform relative to one another. These represent the same data in two different ways: horizontally and vertically. Horizontal statements are more popular because they are easier to read.
How does vertical analysis work?
Vertical analysis works on the principle that if an entity has grown over time, it will have implemented systems that support its organization's growth, particularly about staff quantities and quality (which can be demonstrated through ROI and ROE). Careful analysis of vertical statements can provide a great deal of insight into the quality and resources of an organization.
Disadvantages of vertical analysis:
· Vertical analysis is often tricky for analysts who are not familiar with it, due to its relative novelty in modern financial reporting (it was used more heavily in earlier periods such as the 1960s and 1970s, but less so since then), and because it requires significant knowledge about how business works. The errors that Vertical Analysis uncovers tend to be subtle or complicated, making them easy to miss or ignore for this reason.
· Vertical statements require a lot of work and effort to produce because they need to be calculated each time there is a change in data (which most changes). This means that vertical statements are not updated very frequently. Also, because Vertical Analysis requires a large amount of knowledge about how variables work, it is reserved for those with significant expertise in the subject matter being examined.
Difference between Vertical Analysis &'' Financial Statement Analysis
Financial statement analysis is used to analyze financial statements and determine what they say about their performance over time. It breaks down the numbers into meaningful categories that can then be analyzed using ratios or other methods. Financial statement analysis focuses on data published by companies themselves rather than information inferred from their figures, which is the main difference between financial statement analysis and vertical analysis.
Vertical Analysis &'' Financial Statement Analysis are both forms of financial performance analysis - but they have different aims, i.e., "Vertical" takes a narrower, "vertical" look at the business, which helps to make it easier to understand and thus analyze.
Vertical analysis is used as a tool in many fields such as economics and organizational studies. It is beneficial for identifying patterns or abnormalities. It can also be used to find solutions for problems by helping one focus on the particular areas that need work rather than getting lost in trying to fix everything at once (which can often lead to failure because there's too much going on). Vertical analysis is also helpful in making sense of complex systems since its goal is to simplify things into bite-sized items that are easy to understand independently without disrupting relationships between variables.