Vertical analysis, a method of financial statement analysis, involves expressing individual line items in financial statements as a percentage of a base amount. In this context, calculating net income using vertical analysis entails determining the percentage contribution of each revenue and expense item to the overall net income of a company. For instance, if a company’s revenue is $1,000,000 and its total expenses are $600,000, its net income is $400,000. By using vertical analysis, we can calculate that revenue contributes 100% to net income, while total expenses contribute 60% to net income.
Vertical analysis is a crucial tool for financial analysts and investors as it allows for: (1) assessing the relative significance of various income and expense items; (2) identifying trends and changes in a company’s financial performance over time; and (3) comparing the company’s financial performance to industry benchmarks. Historically, vertical analysis has been employed for decades as a key technique in financial statement analysis, with early applications dating back to the 1920s.