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Mini-Video - Accounting 2 - Chapter 17 Financial Statement Analysis – Vertical Analysis - YouTube
Channel: JCCCvideo
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-Let's take a look at vertical analysis, now
vertical is up and down, right?
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Vertical analysis is when we focus on the
relationship on a financial statement at a
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given point in time, okay?
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And we express each item as a percentage of
a certain amount, okay?
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The base amount that we use for the balance
sheet vertical analysis is total assets.
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The base amount that we use for the income
statement is usually total sales.
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This is going to be best illustrated with
an example so let's look at a fictitious company
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here, Highland Corporation, for two years.
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And let's do common-size statements, in other
words, vertical analysis.
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Okay, well, here is their two years of data,
just looking at two years for time sake here,
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okay?
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Well, we're gonna take every number divided
by the sales for that year, okay?
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So, this 69.2 is achieved by taking the 360,000
divided by the 520,000, okay?
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This 65.6% is a way of saying that cost of
goods sold for 2013 was 65.6% of sales and
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we got that by taking 315,000 divided by 480,000
and you do that for each item, okay?
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Now this is just a real quick example but
what conclusions can we draw?
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Well one thing that would jump out to me right
here is I would do horizontal analysis of
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our vertical analysis computations.
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Let me say that again.
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I would do horizontal analysis over time of
those vertical analysis computations and one
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thing that would alarm me a little bit is
their gross, oh sorry, I circled the wrong
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one.
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Circled the wrong one, sorry.
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This is the one I meant to circle, okay?
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One thing that would alarm me here is that
their gross margin percentage declined from
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34.4% to 30.8%, that's not good, is it?
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That's a big decrease in gross margin percentage,
okay?
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So I don't know what's happening there but
it tells us where we need to investigate.
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Is the cost of our goods that we sell increasing
and we're not able to pass those on to the
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customer or we're just not passing them on
to the customer, or what?
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But our margin is eroding, you see that?
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Okay.
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We take everything divided by sales for the
year to get all of these numbers.
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As I said, horizontal analysis of vertical
metrics is a powerful tool and perhaps you
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see that gross profit percentage is declining
over time or if you do net income divided
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by sales, it is declining over time, okay?
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When I did this, this is horizontal analysis
over time of a vertical measurement, isn't
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it?
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And you can see that whoever this person is,
he is getting quite large, right?
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Okay.
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Address the situation before they have a heart
attack and die, right?
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Okay?
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Seriously, I said this before, we want to
try to solve problems while they're still
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solvable, that's why we use these metrics
and why we use this analysis, okay?
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Back to the computer.
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Some real-world examples of when this was
used.
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Subway did this sort of analysis back in '08
and they realized they had an advantage in
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their margin due to their low food costs and
what they enacted was the $5 Footlong campaign.
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And they did have a decrease in margins but
from their analysis they knew, or they suspected,
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that it would be more than offset by volume
increases and they were correct, total net
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income increased.
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Now Quiznos tried to follow suit but they
had a lower gross margin because their food
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costs were much higher.
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They tried to do the same sort of strategies
as Subway and their margins eroded and they
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could not make them up in increased volume
and a lot of franchises actually went out
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of business, okay, including the one that
I liked to go to, okay?
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So this is a quick example of how this has
been used in real life, okay?
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On a balance sheet, we do vertical analysis
but we take everything divided by the total
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assets, okay?
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That is the base number we use and you can
see this right here.
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Every one of these numbers were divided by
total assets to get whatever number it is,
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okay?
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Now something like this is so much easier
if you know how to use Microsoft Excel, okay?
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If you take Managerial Accounting from me,
you'll learn how to use Microsoft Excel if
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you don't know already, okay?
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And then of course we can a lot of times use
a, make a circle graph out of some of this
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data as well and that can be used in our analysis
purposes as well.
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