Common Size Financial Statement: Definition and Example

Common size analysis is also an excellent tool to compare companies of different sizes but in the same industry. Looking at their financial data can reveal their strategy and their largest expenses that give them a competitive edge over other comparable companies. For example, large drops in the company’s profits in two or more consecutive years may indicate that the company is going through financial distress. Similarly, considerable increases in the value of assets may mean that the company is implementing an expansion or acquisition strategy, potentially making the company attractive to investors. For example, if the value of long-term debt in relation to the total assets value is high, it may signal that the company may become distressed. Let’s now perform the common size of the Income Statement for different periods and analyze the same on the stand-alone period basis and for different years.

It would work the same with liabilities listed as a percentage of total liabilities. It also includes stockholders equity being listed as a percentage of total stockholders equity. The balance sheet provides a snapshot overview of the firm’s assets, liabilities, and shareholders’ equity for the reporting period. A common size balance sheet is set up with the same logic as the common size income statement. The balance sheet equation is assets equals liabilities plus stockholders’ equity. On the other hand, horizontal analysis refers to the analysis of specific line items and comparing them to a similar line item in the previous or subsequent financial period.

One item of note is the Treasury stock in the balance sheet, which had grown to more than negative 100% of total assets. But rather than act as an alarm, this indicates that the company had been hugely successful in generating cash to buy back shares, far exceeding what it had retained on its balance sheet. The cash flow statement in terms of total sales indicates that it generated an impressive level of operating cash flow, averaging 26.9% of sales over three years. The cash flow statement provides an overview of the firm’s sources and uses of cash.

Cash Flow Common Size Analysis

In the prior year, the balance sheet reflected 55 percent debt and 45 percent equity. In the current year, that balance shifted to 60 percent debt and 40 percent equity. The firm did issue additional stock and showed an increase in retained earnings, both totaling a $10,000 increase in equity. However, the equity increase was much smaller than the total increase in liabilities of $40,000. Long-term debt increased by only $10,000 by issuing additional notes payable. The remainder of that increase is seen in the 5 percent increase in current liabilities.

This is why the common size income statement defines all items as a percentage of sales. The term “common size” is most often used when analyzing elements of the income statement, but the balance sheet and the cash flow statement can also be expressed as a common size statement. Financial statements that show onlypercentages and no absolute dollar amounts are common-size statements. Allpercentage figures in a common-size balance sheet arepercentages of total assets while all the items in acommon-size income statement are percentages of netsales. The use of common-size statements facilitatesvertical analysis of a company’s financial statements. Common size balance sheets are similar to common size income statements.

FAQs About Common Size Financial Statement

A net profit margin is simply net income divided by sales, which is also a common-size analysis. Net income represents 10% of total revenues, and this margin can be compared to the previous year’s margin to see the company’s year-over-year performance. By looking at this common size income statement, we can see that the company spent 10% of revenues on research and development and 3% on advertising. On the debt and equity side of the balance sheet, however, there were a few percentage changes worth noting.

1. However, it’s important to recognize that some of these limitations come due to various interpretations of the data being observed.
2. It’s worth noting that if two companies are using different accounting methods the comparisons might not be accurate.
3. In the balance sheet, the common base item to which other line items are expressed is total assets, while in the income statement, it is total revenues.
4. The same formula can be copied and replicated in each income statement line, making the calculations much faster.
5. Common size balance sheets are similar to common size income statements.

The items include selling and general administrative expenses, taxes, revenue, cost of goods sold, and net income. However, a more popular version breaks down cash flow in a different way and expresses line items in terms of cash flows from operations. It will also include total financing cash flows and total investing cash flows for both of those activities. All you need to have is the percentage of the base amount, the total amount of an individual item, and the amount of the base item.

Balance Sheet Analysis

They can also look at the percentage for each expense over time to see if they are spending more or less on certain areas of the business, such as research and development. On the balance sheet, analysts commonly look to see the percentage of debt and equity to determine capital structure. They can also quickly see the percentage of current versus noncurrent assets and liabilities.

Common size financial statements make it easier to determine what drives a company’s profits and to compare the company to similar businesses. Common size financial statements reduce all figures to a comparable figure, such as a percentage of sales or assets. Each financial statement uses a slightly different convention in standardizing figures. One of the benefits of using common size analysis is that it allows investors to identify large changes in a company’s financial statements. It mainly applies when the financials are compared over a period of two or three years. Any significant movements in the financials across several years can help investors decide whether to invest in the company.

Common size analysis, also referred to as vertical analysis, is a tool that financial managers use to analyze financial statements. It evaluates financial statements by expressing each line item as a percentage of a base amount for that period. The analysis helps to understand the impact of each item in the financial statements and its contribution to the resulting figure.

7 Common-Size Statements

This tool is especially important if you’re using key performance indicators to measure your business’s performance and profitability. The approach lets you compare your business to your competitors’ businesses, regardless of size differences. The most significant benefit of a common-size analysis is that it can let you identify large or drastic changes in a firm’s financials. Rapid increases or decreases will be readily observable, such as a fast drop in reported profits accounting and the theory of the firm during one quarter or year.

It’s also possible to use total liabilities to indicate where a company’s obligations lie and whether it’s being conservative or risky in managing its debts. Vertical analysis is especially helpful inanalyzing income statement data such as the percentage of cost ofgoods sold to sales. Where horizontal analysis looked at oneaccount at a time, vertical analysis will look at one YEAR at atime. The common-size balance sheet functions much like the common-size income statement.

In the common size, each element of financial statements (Income Statement and Balance sheet) is shown as a percentage of another item. In the case of the Income Statement, each element of income and expenditure is defined as a percentage of the total sales. The assets, liabilities, and share capital is represented as a percentage of total assets. A common size financial statement is a specific type of statement that outlines and presents items as a percentage of a common base figure. The process of creating a common size financial statement is often what is a triple net nnn lease and whats included in it referred to as a vertical analysis or a common-size analysis. Many items in the cash flow statement can be stated as a percent of total sales, similar to an income statement analysis.