FA 51 - Vertical Analysis
Summary
TLDRThis 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
📊 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.
🔍 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.
🏦 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.
Mindmap
Keywords
💡Vertical Analysis
💡Common-Sized Financial Statement
💡Cost of Goods Sold (COGS)
💡Gross Profit Margin
💡Operating Expenses
💡Profitability
💡Financial Position
💡Current Assets
💡Current Liabilities
💡Long-Term Assets
💡Long-Term Liabilities
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
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