So it's important to be able to analyze financial statements as well as create them in this class. Well, another way we can analyze them is through a vertical analysis. Let's check it out. So you may have previously learned about a horizontal analysis where we do a percentage change from 1 year to the next. If not, you'll learn about it in a different video. Here we're going to learn about the vertical analysis. A vertical analysis is still dealing with percentage changes, but we're not dealing with year over year changes anymore. We're going to be dealing with a percentage of the base amount on the financial statement. So we're going to do this for the income statement and the balance sheet. So let's see what the base amount is going to be for each of those statements.

On the income statement, our base amount is going to be our net sales. Our net sales or just our sales revenue, right? Or our sales revenue if we don't have a net sales amount. We're going to use that top line, sales revenue. Whatever the top line is on your income statement, that's what we're using as our base. And then we're going to have on the balance sheet, our base is going to be our total assets and we're also going to use so for the assets part, we're going to use total assets And for the liabilities and equity, we're going to use total liabilities and equity. But remember, these numbers are the same, aren't they, right? Total assets equal total liabilities and equity. So they're going to be the same number. So either way, we're going to have that number, as our balance sheet base.

What do I mean when I say base? That's what we're going to use as the denominator in our percentage formula. So remember that when we find the percentage of the base, what we're going to do is we're going to take the line item amount, say, selling expense like we have down here and we're going to divide it by the base amount. So if that was on the income statement, it would be the selling expense, whatever that amount is for the year divided by the net sales, because we're dealing with the income statement. And remember that we're getting a percentage, so we are going to multiply this by 100 to move the decimal place 2 places and get a percentage.

Let me go ahead and show you how we do a vertical analysis here on an income statement and then you guys can get some practice on a balance sheet. So let's go ahead and do it for 2 years here. We've got 2018 and we've got our net sales. So remember that net sales, this is our base amount. This is always going to be the denominator. In every single one of our calculations, the base amount is net sales for that year. So 2018, the base amount is always going to be 65455 and when we do 2017, it'll always be 58081.

Let's go ahead and do a couple of them and then I'm going to speed it up. I've done a lot of these calculations ahead of time. It's just going to be a lot of number crunching, that's why we became accountants because we love using our calculator. Hit all those buttons. Let's go ahead and do it. So net sales, this one's always going to be 100%, right? It's going to be 100% of itself. This calculation, we would do 65455, the line item amount divided by the base amount which is net sales. So that's going to be obviously 1, we multiply it by 100 to get the percentage and that one is 100%. So net sales is 100% of itself. Wow, that's very revealing information. Let's go on down and we'll start getting some better information.

How about cost of goods sold? So remember the numerator is going to be the line item. So 54912 is our numerator and we divide it by net sales, right? Net sales is always going to be the denominator. 65455. Alright. So let's go ahead and you just do that division and we'll get it as a percentage and we see that it's 83.9%. I'm going to be rounding just to one decimal here.

We can do our vertical analysis to subtotals as well. Remember, gross profit is a subtotal. It's not its own expense or revenue. It's a subtotal. It's just net sales minus cost of goods sold. Well, we can find out what gross profit is out of net sales. So you do the same thing, 10543 divided by net sales, the same number 65455 and we get it as a percentage. We multiply by 100 to get a percentage and we'll get 16.1%.

Already we can see that out of net sales, 83%. So for every dollar of net sales, almost 84% of it is going to pay for the cost of goods sold and we're left with 16% at this point. And then we still got to pay for other stuff. We're going to have other expenses and we're going to end up with our net income. So this lets us know how much of a percent of net sales. So we get a dollar of sales, how much of that is going to different places.

Let's keep going here with our operating expenses. So I'm going to write this one out, but after this, I think you should get the point of how we do this calculation and I'm going to start putting in our percentages. So 2411, right? Our line item is our numerator divided by 65455 still using that same, net sales amount as our numerator, and let's go ahead do that division and we get 3.7%. We keep going 982 divided by 65455 and we get 1.5%. So we know for every dollar of sales, what 1.5% of that is going to selling expenses. Maybe some commission we pay to our salesperson, they get 1.5% off of every sale. Depreciation expense, 1400 divided by 65455. Same thing. 2.1% here and we can do it with total operating expenses. How much are our total operating expenses as a percentage of our sales? And we get 7.3% here.

Another subtotal, income from operations, right? This is where we take our gross profit minus those operating expenses. This is all of our core business. How much are we making? Well, 5750 out of that 65455 that comes out to be 8.8%. That means for every dollar of sales, well, we're keeping 8.8% from operations, and then we've got a couple more things we got to pay for, and then we're left with our net income.

So let's do those. Next, we've got interest expense, 480 divided by 65455 and we're going to get 0.7%. How about the next one? Other expenses, look how small this is $70. That doesn't seem like a very big part of net sales. We do our calculation 70 divided by 65455, 0.1%. Vertical analysis is pretty easy, right? We're just doing this simple division. All you g