In vertical analysis, each item in a financial statement is expressed as a percentage of some base item. When analyzing a balance sheet vertically, all accounts are listed as a percentage of total assets. Vertical analysis, also known as common-size analysis, is particularly useful for comparing information among companies of different sizes. Managers can also perform vertical analysis of a series of balance sheets to see how account balances change over time.
Prepare the Balance Sheet
Before you can perform a vertical analysis of a balance sheet, you first need a completed balance sheet. In a "balanced" balance sheet, assets plus liabilities equals stockholders' equity. Sum all of the asset accounts to calculate total assets. This number is your base figure for the vertical analysis.
Typical asset accounts include inventory, accounts receivable, investments, fixed assets and intangible assets. Next to the line item for total assets, write "100%".
Express Accounts as a Percentage
To conduct a vertical analysis of a balance sheet, express each individual asset account line item as a percentage of total assets. For example, if inventory is $10,000 and total assets is $200,000, write "5%" next to the inventory line item amount. Repeat this process for each account in the liabilities and stockholders' equity section.
Under the "Total Stockholders' Equity" line item, ensure there is a line item that reads "Total Liabilities and Stockholders' Equity". If it does not exist, write it in. Double-check that that the total of liabilities and stockholders' equity equals total assets and write "100%" next to the line item total.
Compare Financial Data
Compare your results to competitors or similar companies in your industry. You can find the balance sheets for public companies by searching the Securities and Exchange Commission (SEC) database. Privately held companies often publish their financials in the investor relations section of their websites.
For best results, perform vertical analysis on a handful of company balance sheets and calculate the average to establish a baseline balance for each account. Compare your company results to the baseline and note any significant differences. In addition to industry baselines, compare your current common-size balance statement with previous years and note significant growth or decline in any accounts. If your company number is within 10% of the expected number, it is typically considered within range.
Vertical Analysis Interpretation
If you do notice large variances or odd trends, it is not necessarily a bad thing. When you identify significant differences, try to determine why the number is different. Look at other asset accounts for clues. For example, if accounts receivable is higher than normal and cash is lower than normal, it could be that the company is having trouble collecting sales made on credit.
If necessary, talk with different department managers and ask their opinions on certain numbers. After performing some preliminary analysis, executive management can then analyze the variances to determine the underlying causes and decide if the variance helps or hurts company performance.