08/27/24
Vertical Analysis
Author: David Sun
The fundamental goal of a business is to make money. Thus, as investors, one of our primary tasks is to evaluate how a company makes money. One of the first methods we learn of is comparing revenue streams. For example, if a company has two products, A and B, we may compare the revenue generated by product A vs product B or the number of units sold of product A vs product B. However, if we want to take a step further, we may also want to evaluate how a company manages and spends its money. We may do this with the same logic in mind in a process known as vertical analysis.
To set up vertical analysis, we express each element of the section of the form we’re analyzing (e.g. assets from the balance sheet, income statement, etc.) as a percentage of a total. In the example above, every element is part of the company’s total assets. Therefore, each percentage is calculated by dividing the element's value by the total assets. Once we've finished this, the sum of all the percentages we've determined should add up to 100.
And that’s it! We’ve completed a vertical analysis of the company’s total assets. With this, we’ve unlocked yet another lens with which we may analyze a company. We may see what makes up a company’s assets, liabilities, revenue, etc. In the example above, a vertical analysis has been set up for each of the first three quarters of fiscal year 2022. By creating a side-by-side comparison of different periods, we may identify trends. For example, the total current assets increased across the three quarters due to an increase in cash. Additionally, we may create vertical analyses of competitors to compare their cost structures.
Conclusion
Through vertical analysis, we may better understand how a company earns, spends, and manages its money. With this insight, we may also make more informed comparisons between competitors.