FA 51 - Vertical Analysis

Summary

This video tutorial delves into vertical analysis, a method for comparing financial statements within a single year rather than across years. The presenter uses the income statements of two companies, Gil and Hossein Inc., to demonstrate how to convert figures into percentages of sales or total assets, revealing insights into profitability and financial stability. The analysis shows Gil has better cost control and profitability, while Hossein has a stronger financial position with higher current assets and lower liabilities.

Takeaways

• 📘 The video script discusses the process of vertical analysis, a method for comparing financial statements within a single year rather than across years.
• 📊 Vertical analysis, also known as common-sized financial statements, helps to compare companies of different sizes by restating all figures as percentages.
• 🍔 The example used in the script involves comparing the financial statements of a small company, Gil, with its much larger competitor, Hossein Inc.
• 🔍 The script demonstrates how to perform vertical analysis on an income statement, with all figures expressed as a percentage of sales.
• 📈 The comparison reveals that Gil has higher profit margins and lower operating expenses as a percentage of sales compared to Hossein Inc.
• 💰 The script also shows how to apply vertical analysis to a balance sheet, with all figures expressed as a percentage of total assets.
• 🏦 The balance sheet analysis indicates that Hossein has a more stable financial position with higher current assets relative to current liabilities and a stronger equity position.
• 📉 Despite having better profitability, Gil's financial position is considered weaker due to a lower ratio of current assets to current liabilities and a higher total liabilities.
• 📚 The video script is part of a series available on a website, which includes both public and members-only content for subscribers.
• 🔗 The website mentioned in the script offers downloadable PDFs and additional video content beyond what is publicly listed on YouTube.
• 🤔 The script suggests that a viewer might prefer Gil's income statement for its profitability but would prefer Hossein's balance sheet for its financial stability.

Q & A

What is the main purpose of vertical analysis in financial statements?

Vertical analysis is used to evaluate financial statements by expressing each item as a percentage, allowing for a comparison of the relative size of different accounts within a single year, rather than comparing across years or between different companies.

What is another term for vertical analysis?

Vertical analysis is also commonly referred to as common-sized financial statements.

Why is it difficult to compare financial statements of companies of significantly different sizes?

Comparing financial statements of companies of different sizes is challenging because the absolute dollar amounts do not relate well. For example, a small company with hundreds of thousands in revenue cannot be directly compared to a large company with billions in revenue.

What is the first step in performing a vertical analysis of an income statement?

The first step in performing a vertical analysis of an income statement is to restate every item as a percentage of sales. This means dividing each item by the total sales figure.

How does vertical analysis help in comparing the profitability of two companies?

Vertical analysis helps in comparing profitability by showing the cost structure and profit margins as a percentage of sales, which allows for a more meaningful comparison of companies of different sizes.

What does the term 'COGS' stand for in the context of financial statements?

In financial statements, 'COGS' stands for 'Cost of Goods Sold', which represents the direct costs attributable to the production of the goods sold by a company.

What does a higher gross profit margin indicate about a company's cost control?

A higher gross profit margin indicates that a company has better cost control, as it is able to sell its products at a higher percentage above its cost of goods sold.

How are common-sized balance sheets prepared?

Common-sized balance sheets are prepared by expressing each item as a percentage of the company's total assets, making the total assets 100% and adjusting all other figures proportionally.

What does the ratio of current assets to current liabilities indicate about a company's short-term financial health?

The ratio of current assets to current liabilities indicates a company's ability to pay its short-term obligations. A higher ratio suggests a stronger financial position in terms of liquidity.

What does the comparison of Hossein Inc. and Gil Ink's financial statements reveal about their respective financial positions?

The comparison reveals that while Gil Ink has better financial performance with lower costs and higher profitability, Hossein Inc. is in a stronger financial position with a higher ratio of current assets to current liabilities and a more balanced mix of total liabilities and equity.

What is the conclusion of the vertical analysis performed on the companies in the video script?

The conclusion is that Gil Ink has better financial performance due to lower costs and higher profitability, but Hossein Inc. has a stronger financial position with a more stable balance sheet, indicating a mixed bag of financial health for both companies.

Outlines

00:00

📊 Introduction to Vertical Analysis in Financial Statements

The video script introduces the concept of vertical analysis, a method used to evaluate a company's financial performance by comparing the relative size of different accounts within a single year's financial statements. The script explains that this technique, also known as common-sized financial statements, helps to overcome the challenge of comparing companies of different sizes by expressing all figures as a percentage of a base figure, typically sales or total assets. The video provides a step-by-step guide on how to perform vertical analysis on an income statement and balance sheet, using the example of two companies, Gil and Hossein Inc., to demonstrate the process.

05:11

🔍 Comparative Analysis of Gil and Hossein Inc.'s Financial Performance

In this paragraph, the script delves into a detailed vertical analysis comparison between Gil and Hossein Inc.'s income statements, highlighting the differences in cost control and profitability. The analysis reveals that Gil has higher profit margins and lower operating expenses as a percentage of sales, suggesting better financial performance in terms of profitability. Key figures such as cost of goods sold, gross profit, and operating expenses are examined, with a focus on how these percentages indicate the companies' financial health and efficiency.

10:12

🏦 Evaluating Financial Position Through Balance Sheet Analysis

The final paragraph of the script shifts the focus to the balance sheets of both companies, applying the vertical analysis technique to assess their financial positions. The script compares the proportion of current and long-term assets and liabilities, as well as shareholders' equity, to determine the stability and health of each company's financial structure. The analysis suggests that while Gil has better financial performance, Hossein is in a stronger financial position due to higher current assets relative to current liabilities and a more balanced total liabilities and equity ratio.

Keywords

💡Vertical Analysis

Vertical analysis is a method used to evaluate financial statements by expressing each item as a percentage of a base figure, often the total revenue or total assets. In the video, vertical analysis is applied to both the income statement and balance sheet of two companies, Gil and Hossein Inc., to compare their financial performance and position within a single year, rather than over multiple years.

💡Common-Sized Financial Statement

A common-sized financial statement is a presentation of a company's financials where all figures are expressed as a percentage of a specific base value, typically the total assets or total revenue. This allows for easier comparison of financial data across companies of different sizes. In the video, the instructor explains how to prepare common-sized income statements and balance sheets as part of the vertical analysis process.

💡Cost of Goods Sold (COGS)

Cost of Goods Sold refers to the direct costs attributable to the production of the goods sold by a company. It includes material and labor costs but excludes indirect costs like rent or utilities. In the script, COGS is used to calculate the gross profit margin for both Gil and Hossein Inc., highlighting the difference in their ability to markup their products.

💡Gross Profit Margin

Gross profit margin is a financial metric that indicates the profit a company makes from its sales after deducting the cost of goods sold. It is calculated as (Revenue - COGS) / Revenue. The video script uses the gross profit margin to compare the profitability of Gil and Hossein Inc., showing that Gil has a higher margin, indicating better cost control.

💡Operating Expenses

Operating expenses are the costs a company incurs to generate revenue, excluding the cost of goods sold. These can include salaries, rent, utilities, and marketing costs. In the video, the instructor compares the operating expenses of Gil and Hossein Inc. as part of the vertical analysis, noting that Gil has lower operating expenses as a percentage of sales.

💡Profitability

Profitability refers to the ability of a company to generate profit from its operations. It is a key indicator of a company's financial health and efficiency. The video script discusses the profitability of Gil and Hossein Inc., concluding that Gil is in a better profitability position due to lower costs as a percentage of revenue.

💡Financial Position

Financial position refers to the overall financial health of a company, often assessed by looking at its assets, liabilities, and equity. In the video, the financial position of Hossein Inc. is compared to Gil's, with the conclusion that Hossein is in a stronger financial position due to higher current assets relative to current liabilities and a more balanced mix of liabilities and equity.

💡Current Assets

Current assets are assets that a company expects to convert to cash or use up within one year in the normal course of business. They include cash, accounts receivable, and inventory. The video script discusses the current assets of both companies, noting that Hossein has a higher amount of current assets compared to its current liabilities, indicating better short-term financial stability.

💡Current Liabilities

Current liabilities are obligations a company expects to settle within one year. They include accounts payable, short-term loans, and accrued expenses. In the video, the instructor compares the current liabilities of Gil and Hossein Inc., highlighting that Hossein has a more favorable ratio of current assets to current liabilities.

💡Long-Term Assets

Long-term assets, also known as non-current assets, are assets a company expects to keep and use for more than one year. They include property, plant, equipment, and long-term investments. The video script uses the vertical analysis to compare the proportion of long-term assets to total assets for both companies.

💡Long-Term Liabilities

Long-term liabilities are debts or obligations that a company expects to pay off over a period longer than one year. They include long-term loans and bonds payable. The video script discusses the long-term liabilities of both Gil and Hossein Inc., as part of the balance sheet analysis, showing that Hossein has a higher proportion of long-term liabilities, which may indicate a different capital structure.

Highlights

The video discusses vertical analysis for financial statements, also known as common-sized financial statements.

Vertical analysis helps compare financial data within a single year, rather than year-over-year.

The method involves restating all items on the income statement or balance sheet as a percentage of sales or total assets.

Harpreet Gil's company is compared to a larger competitor, Hossein Inc, to analyze financial performance and position.

Gil's company shows higher profit margins due to better cost control compared to Hossein Inc.

Gil's income statement indicates a more profitable business with lower costs as a percentage of revenue.

Hossein Inc has a more stable financial position with higher current assets to cover current liabilities.

The video provides a step-by-step guide on how to perform vertical analysis for both income statements and balance sheets.

The transcript offers practical insights into comparing companies of different sizes for financial analysis.

Gil's company has lower operating expenses, contributing to better cost management.

Hossein Inc's balance sheet shows a healthier financial position with a better current assets to liabilities ratio.

The video concludes that while Gil's has better financial performance, Hossein Inc is in a stronger financial position.

The importance of understanding both financial performance and position when analyzing companies is emphasized.

The video provides a clear example of how to compare financial statements using vertical analysis.

A downloadable workbook with problems and solutions is available for those interested in practicing vertical analysis.

The video includes both public and members-only content, with additional videos available on the website.

The video concludes with a summary of the findings from the vertical analysis of Gil's and Hossein Inc's financial statements.

Transcripts

the problem from this video can be

downloaded at a counting workbook com if

you go to the website click the PDF link

and you can download a copy of this and

all of my problems for yourself now if

you check the website and you click on

videos you'll see there are more videos

than those I've listed publicly on

YouTube you can see that there's every

problem covered in the workbook has

either a public video or a members-only

video if you'd like access to the

members only video just click the join

button beneath the video player on

YouTube alright let's jump into the

problem we're taking a look at 12 2a

this problem is on vertical analysis and

we set our gesture for horizontal look

like this our gesture for vertical looks

like this we're analyzing the financial

statements not by looking year over year

looking at a timeline or some sort of

trend line we're looking up and down one

single year and just looking at how how

the accounts compare with each other now

vertical analysis is often called common

sized financial statement and we're

gonna learn how to prepare common sized

income statements and common size

balance sheets if I have my hamburger

company here in Kamloops and I'm selling

you know tens of thousands of dollars

worth of burgers a year or a month even

and I want to compare my income

statement to McDonald's is they just

don't compare cuz McDonald's has

billions and billions of dollars in

revenue and I might have tens or even

hundreds of thousands it just doesn't

even relate right vertical analysis

helps us overcome that and we'll see

that in this problem let's let's read

through it Harpreet Gil is concerned

about his company's financial

performance and financial position he's

obtained the financial statements of his

largest competitor Hossein Inc and notes

that the company is over ten times

larger than his so it is making

different numbers difficult to compare

below his condense financial information

from Hossein Inc and Gil ink and you can

see Hossein is just a way bigger company

you know millions more in sales and just

bigger balance sheet bigger everything

so let's zoom in on the income statement

and

we're going to do a vertical analysis

that was what the question called for

and here's how you do a vertical

analysis you restate everything you see

on the income statement or the balance

sheet as a percentage now on the income

statement

everything gets restated as a percentage

of sales so I want to do vertical

analysis I'll start with Gil will do

Hossein in a minute but we'll start with

Gil so let's just ignore Hossein for the

time being don't you scratch that out

you're gonna use that and you know I'll

erase it see it's easy for me to erase

but we're gonna focus in on Gil and

vertical right so I'm not comparing

company to company just yet I'm just up

and down so here's what you do you

basically divide every number on here by

the sales number whatever the sales

number is to divide by that so 400

thousand divided by four hundred

thousand gives us a hundred percent 120

divided by four hundred thousand let's

see 1 200 divided by 400 gives us 30%

280 divided by 400 gives us 70 percent

that shouldn't be a surprise given the

math 100 minus 30 is 71 30 divided by

400 gives us 32.5% 150 divided by 400

37.5% 10 divided by 400 2.5% 140 divided

by 400 35 percent and the math by the

way is working down as well like 37

point 5 minus 2 point 5 is 35 30 divided

by 400 7.5 percent and 110 divided by

400 27.5% double underline there let's

do hosting

five million now we divide every number

by Hossein x' sales so five million

divided by five million is a hundred

percent our top line here it's always

gonna be a hundred percent cost of it

sold 2.1 million oh my gosh divided by 5

million 42% 2.9 million divided by 5

million 58% 2.2 million divided by 5

million 44% 700,000 divided by 5 million

14% sixty divided by five million what a

1.2 percent

I almost said 12% there happens with

students on tests 6 40 divided by 5

million 12.8% 150 divided by 5 million 3

percent and 490 divided by 5 million

nine point eight percent double

underline there and we've done it so

let's kind of compare these and see if

anything jumps out and hmm just

eyeballing this it appears to me that

gills costs are way more under control

than ho Saenz right key numbers are

again the big ones with big differences

are like cogs were able to markup

they'll do cogs and gross profit all at

once we're able to markup 70% over our

cost we're Hossein is not so we have way

higher margin though maybe they're low

cost low volume I'm not sure the the the

competitive nature here but we have way

higher margins then does our largest

competitor the other thing is our

operating expenses are lower so our

costs are way more under control if you

didn't know anything if you didn't know

these numbers if you just saw the

percentages right Hossein or Gil whose

income statement would you rather have

I'd rather have gills so Gil is in

better profitability position then is

hossein that I think we can say and the

reason is its costs are lower as a

percentage of revenue its costs are

significantly lower okay let's move over

to the balance sheets and with the

balance sheet you do something very

similar you set everything to a hundred

percent based on or based on a

percentage of total assets whatever the

total assets is you make that number

eight percent you know they make that

number a hundred percent and every other

number is a percentage just driven from

that so let's do Hossein a million

divided by four million twenty five

percent current 75 percent long term

five hundred divided by again four

million is our denominator for all this

12.5 percent there 1.5 million divided

by four million

thirty seven point five percent fifty

percent for total liabilities fifty

percent for shareholders equity two

divided by four is fifty and a hundred

percent for total liabilities and shows

exactly because it's 4 million divided

by four million let's move over and do

Gil Gil is 75 divided by 250 30% for

current assets 175 divided by 250

seventy percent for long-term assets

moving down to current liabilities sixty

divided by 250 24 percent

24-point Oh percent for Current

Liabilities

120 divided by 250 48 percent for

long-term liabilities and 180 divided by

250 72 percent for total liabilities

Sheryl ders equity seventy divided by

250 28% bringing us to a hundred percent

ok let's compare now the balance sheets

so eyeballing it a few things to look at

one is just this current assets current

liabilities that kind of ratio and you

can see just eyeballing it that Hossein

has like double the current assets

required to pay its current liabilities

where Gil has his covered but just

barely and the other thing to look at is

just like the total liabilities and

Geils are much higher the total equity

Gill's are much lower I definitely

prefer Hussein's balance sheet right

it's in a much more stable financial

position or much healthier financial

position so in terms of financial

performance

I like Gil's income statement better in

terms of financial position

I like Hussein's much better so better

both better you know it's it's not a

homerun for Gil and it's a mixed bag

here mixed news so I think we've done it

we've done our vertical analysis of the

companies that's just those percentages

we've commented on the common size

income statements I think a simple

comment which is you say Gil's is better

because his costs are more under control

cost of goods sold is lower operating

expenses are lower and therefore Gil is

more profitable than Jose and so Gil's

income statement is in a stronger

financial position ho Saenz balance

sheet is in a stronger or Gil's income

statement

actually not I said financial position

the word is financial performance is

better for Gill financial position is

better for Hossein and the reason I say

that is the current assets compared to

current liabilities are stronger for

Hossein the total liabilities and total

equity are both stronger for Hossein so

Hossein is in the stronger financial

position Gill had the better financial

performance okay that's it for this

video stay tuned for our next one bye

for now