chapter 13 - Vertical analysis, also called common-size...

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Vertical analysis , also called common-size analysis, is a technique for evaluating financial statement data that expresses each item in a financial statement as a percent of a base amount . For example, on a balance sheet we might say that current assets are 22% of total assets (total assets being the base amount). Or on an income statement we might say that selling expenses are 16% of net sales (net sales being the base amount). Presented in Illustration 13-13 is the comparative balance sheet of Kellogg for 2007 and 2006, analyzed vertically. The base for the asset items is total assets , and the base for the liability and stockholders' equity items is total liabilities and stockholders' equity . In addition to showing the relative size of each category on the balance sheet, vertical analysis may show the percentage change in the individual asset, liability, and stockholders' equity items. In this case, current assets increased $290 million from 2006 to 2007, and they increased from 22.6% to 23.8% of total assets. Property assets (net) decreased from 26.3% to 26.2% of total assets. Other assets decreased from 51.1% to 50.0% of total assets. Also, retained earnings increased by $806 million from 2006 to 2007, and total stockholders' equity increased from 19.3% to 22.1% of total liabilities and stockholders' equity. This switch to a higher percentage of equity financing has two causes: First, while total liabilities increased by $226 million, the percentage of liabilities declined from 80.7% to 77.9% of total liabilities and stockholders' equity. Second, retained earnings increased by $806 million, going from 24.1% to 29.7% of total liabilities and stockholders' equity. Thus, the company shifted toward equity financing by relying less on debt and by increasing the amount of retained earnings. Vertical analysis of the comparative income statements of Kellogg, shown in Illustration 13-14 , reveals that cost of goods sold as a percentage of net sales increased from 55.8% to 56.0%, and selling and administrative expenses increased from 28.0% to 28.1%. Net income as a percent of net sales increased from 9.1% to 9.4%. Kellogg's increase in net income as a percentage of sales is due primarily to the decrease in interest expense and income tax expense as a percent of sales.
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Vertical analysis also enables you to compare companies of different sizes. For example, one of Kellogg's main competitors is General Mills. Using vertical analysis, we can more meaningfully compare the condensed income statements of Kellogg and General Mills Although Kellogg's net sales are less than those of General Mills, vertical analysis eliminates the impact of this size difference for our analysis. Kellogg has a higher gross profit percentage 44.0%, compared to 36.1% for General Mills, but Kellogg's selling and administrative expenses are 28.1% of net sales, while those of General Mills are 19.2% of net sales. Looking at net income, we see that the companies report similar percentages: Kellogg's net
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chapter 13 - Vertical analysis, also called common-size...

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