What does vertical analysis involve?

Vertical analysis is a technique that involves evaluating each line item in a financial statement as a percentage of a base figure within that statement. This method is particularly useful in analyzing financial statements such as the income statement and the balance sheet, allowing for easy comparisons across different sizes of companies or across periods for the same company.

For example, on an income statement, each revenue and expense item can be expressed as a percentage of total revenues, which helps analysts understand the relative size and importance of each financial metric. Similarly, on a balance sheet, individual asset, liability, and equity items might be expressed as percentages of total assets. This method emphasizes the relationship between the components of a financial statement and the total, facilitating a clearer insight into the company's financial structure and operational efficiency.

While comparing statement items to previous statements looks at trends over time, and evaluating historical trends assesses changes over long periods, neither approach captures the immediate relationship between individual items and a base amount in the same way vertical analysis does. Analyzing cash flows against revenues is also an important aspect of financial analysis, but it does not fall under the definition of vertical analysis.