Learning Outcome
- Perform a vertical analysis of a company’s financial statements
A vertical analysis of financial statements often reports the percentage of each line item to a total amount. Vertical analysis can be used to compare and identify trends within a company from year to year (intracompany) or between different companies (intercompany).
Intracompany Analysis
On the comparative income statement, the amount of each line item is divided by the sales number, which is called the “base”.
| Description | 2019 | 2019 (%) | 2018 | 2018 (%) |
|---|---|---|---|---|
| Sales | $994,000 | 100.00% | $828,000 | 100.00% |
| Cost of merchandise sold | 414,000 | 41.6% | 393,000 | 47.5% |
| Gross Profit | Single Line$580,000 | 58.4% | Single Line$435,000 | 52.5% |
| Subcategory, Operating Expenses: | ||||
| Salaries expense | $77,000 | 7.7% | $64,000 | 7.7% |
| Rent expense | 63,000 | 6.3% | 52,000 | 6.3% |
| Insurance expense | 56,000 | 5.6% | 46,000 | 5.6% |
| Supplies expense | 49,000 | 4.9% | 41,000 | 5.0% |
| Advertising expense | 42,000 | 4.2% | 35,000 | 4.2% |
| Depreciation expense | 35,000 | 3.5% | 29,000 | 3.5% |
| Utilities expense | 28,000 | 2.8% | 23,000 | 2.8% |
| Total operating expense | Single Line348,000 | 35.0% | Single Line290,000 | 35.0% |
| Net income from operations | $232,000 | 23.3% | $145,000 | 17.5% |
| Subcategory, Other revenue and expenses | ||||
| Gain on sale of investments | $137,000 | 13.8% | $186,000 | 22.5% |
| Interest expense | (55,000) | 5.5% | (50,000) | 6.0% |
| Income before income tax | $314,000 | 31.6% | $281,000 | 33.9% |
| Income tax expense | 66,000 | 6.6% | 50,000 | 6.0% |
| Net income | Single Line$248,000 Double Line | 24.9% | Single Line$231,000 Double Line | 27.9% |
On the comparative balance sheet, the amount of each line item is divided by total assets.
| 2019 | 2019 (%) | 2018 | 2018 (%) | |
|---|---|---|---|---|
| Assets | ||||
| Subcategory, Current assets: | ||||
| Cash | $373,000 | 9.4% | $331,000 | 9.2% |
| Marketable securities | 248,000 | 6.3% | 215,000 | 6.0% |
| Accounts receivable | 108,000 | 2.7% | 91,000 | 2.5% |
| Merchandise Inventory | 55,000 | 1.4% | 48,000 | 1.3% |
| Prepaid insurance | 127,000 | 3.2% | 115,000 | 3.2% |
| Total current assets | Single Line$911,000 | 23.1% | Single Line$800,000 | 22.2% |
| Subcategory, Long-term investments: | ||||
| Investment in equity securities | $1,946,000 | 49.3% | $1,822,000 | 50.5% |
| Subcategory, Property, plant and equipment: | ||||
| Equipment (net of accumulated depreciation) | $87,000 | 2.2% | $42,000 | 1.2% |
| Building (net of accumulated depreciation) | 645,000 | 16.3% | 581,000 | 16.1% |
| Land | 361,000 | 9.1% | 361,000 | 10.0% |
| Total property, plant and equipment | $1,093,000 | 27.7% | $984,000 | 27.3% |
| Total assets | Single Line$3,950,000Double Line | 100.00% | Single Line$3,606,000Double Line | 100.00% |
| Liabilities | ||||
| Subcategory, Current liabilities: | ||||
| Accounts payable | $120,000 | 3.0% | $109,000 | 3.0% |
| Salaries payable | 244,000 | 6.2% | 222,000 | 6.2% |
| Total current liabilities | Single Line$364,000 | 9.2% | Single Line$331,000 | 9.2% |
| Subcategory, Long-term liabilities | ||||
| Mortgage note payable | $83,000 | 2.1% | $83,000 | 2.3% |
| Bonds payable | 828,000 | 21.0% | 745,000 | 20.7% |
| Total long-term liabilities | Single Line$911,000 | 23.1% | Single Line$828,000 | 23.0% |
| Total liabilities | $1,275,000Double Line | 32.3% | $1,159,000Double Line | 32.1% |
| Stockholders’ Equity | ||||
| Preferred $1.50 stock, $20 par | $166,000 | 2.1% | $166,000 | 2.3% |
| Common stock, $10 par | 83,000 | 4.2% | 83,000 | 4.6% |
| Retained earnings | 2,426,000 | 61.4% | 2,198,000 | 61.0% |
| Total stockholders’ equity | Single Line$2,675,000 | 67.7% | Single Line$2,447,000 | 67.9% |
| Total liabilities and stockholders’ equity | $3,950,000Double Line | 100.00% | $3,606,000Double Line | 100.00% |
On both financial statements, percentages are presented for two consecutive years in order for the percent changes over time to be evaluated.
Intercompany Analysis
The use of percentages converts a company’s dollar amounts on its financial statements into values that can be compared to other companies whose dollar amounts may be different.
Common-size statements include only the percentages that appear in either a horizontal or vertical analysis. They often are used to compare one company to another or to compare a company to other standards, such as industry averages.
The following compares the performance of two companies using a vertical analysis on their income statements for 2019.
| Description | Jonick | Schneider |
|---|---|---|
| Sales | 100% | 100% |
| Cost of merchandise sold | 41.6% | 47.5% |
| Gross Profit | 58.4% | 52.5% |
| Total operating expense | 35.0% | 35.0% |
| Net income from operations | 23.3% | 17.5% |
| Subcategory, Other revenue and expenses | ||
| Gain on sale of investments | 13.8% | 22.5% |
| Interest expense | 5.5% | 6.0% |
| Income before income tax | 31.6% | 33.9% |
| Income tax expense | 6.6% | 6.0% |
| Net income | 24.9% | 27.9% |
The common-size income statements for Jonick Corporation and Schneider Corporation show that Schneider has lower gross profit and net income from operations percentages to sales. Yet Schneider has a higher overall net income due to much greater gains on the sale of investments.
From an investor’s standpoint, Jonick is better at making money from operations. Schneider may or may not be able to sustain profits from sales of investments. Normally, if you were comparing retail or manufacturing companies, you would be more interested in profits from operations, since that is the core business function. This analysis might lead you back to more a horizontal analysis of Schneider and Jonick in order to determine why so much income is being generated from the sale of investments.
Now, take what you’ve learned and practice your knowledge.
PRACTICE QUESTION
