-Let's take a look at vertical analysis, now vertical is up and down, right?
Vertical analysis is when we focus on the relationship on a financial statement at a
given point in time, okay?
And we express each item as a percentage of a certain amount, okay?
The base amount that we use for the balance sheet vertical analysis is total assets.
The base amount that we use for the income statement is usually total sales.
This is going to be best illustrated with an example so let's look at a fictitious company
here, Highland Corporation, for two years.
And let's do common-size statements, in other words, vertical analysis.
Okay, well, here is their two years of data, just looking at two years for time sake here,
okay?
Well, we're gonna take every number divided by the sales for that year, okay?
So, this 69.2 is achieved by taking the 360,000 divided by the 520,000, okay?
This 65.6% is a way of saying that cost of goods sold for 2013 was 65.6% of sales and
we got that by taking 315,000 divided by 480,000 and you do that for each item, okay?
Now this is just a real quick example but what conclusions can we draw?
Well one thing that would jump out to me right here is I would do horizontal analysis of
our vertical analysis computations.
Let me say that again.
I would do horizontal analysis over time of those vertical analysis computations and one
thing that would alarm me a little bit is their gross, oh sorry, I circled the wrong
one.
Circled the wrong one, sorry.
This is the one I meant to circle, okay?
One thing that would alarm me here is that their gross margin percentage declined from
34.4% to 30.8%, that's not good, is it?
That's a big decrease in gross margin percentage, okay?
So I don't know what's happening there but it tells us where we need to investigate.
Is the cost of our goods that we sell increasing and we're not able to pass those on to the
customer or we're just not passing them on to the customer, or what?
But our margin is eroding, you see that?
Okay.
We take everything divided by sales for the year to get all of these numbers.
As I said, horizontal analysis of vertical metrics is a powerful tool and perhaps you
see that gross profit percentage is declining over time or if you do net income divided
by sales, it is declining over time, okay?
When I did this, this is horizontal analysis over time of a vertical measurement, isn't
it?
And you can see that whoever this person is, he is getting quite large, right?
Okay.
Address the situation before they have a heart attack and die, right?
Okay?
Seriously, I said this before, we want to try to solve problems while they're still
solvable, that's why we use these metrics and why we use this analysis, okay?
Back to the computer.
Some real-world examples of when this was used.
Subway did this sort of analysis back in '08 and they realized they had an advantage in
their margin due to their low food costs and what they enacted was the $5 Footlong campaign.
And they did have a decrease in margins but from their analysis they knew, or they suspected,
that it would be more than offset by volume increases and they were correct, total net
income increased.
Now Quiznos tried to follow suit but they had a lower gross margin because their food
costs were much higher.
They tried to do the same sort of strategies as Subway and their margins eroded and they
could not make them up in increased volume and a lot of franchises actually went out
of business, okay, including the one that I liked to go to, okay?
So this is a quick example of how this has been used in real life, okay?
On a balance sheet, we do vertical analysis but we take everything divided by the total
assets, okay?
That is the base number we use and you can see this right here.
Every one of these numbers were divided by total assets to get whatever number it is,
okay?
Now something like this is so much easier if you know how to use Microsoft Excel, okay?
If you take Managerial Accounting from me, you'll learn how to use Microsoft Excel if
you don't know already, okay?
And then of course we can a lot of times use a, make a circle graph out of some of this
data as well and that can be used in our analysis purposes as well.