A Common Size Financial Statement allows for the straightforward analysis and comparison of financial information between companies or across different periods for the same company. It represents each line item as a percentage of a common base figure, providing a clearer perspective on the relative size and proportion of different components.
Types of Common Size Financial Statements
Common Size Income Statement
In a common size income statement, each item is expressed as a percentage of total revenue. This helps to understand how each expense item and net income relate to total sales.
Common Size Balance Sheet
In a common size balance sheet, each item is expressed as a percentage of total assets. This aids in comparing the financial structures of companies by focusing on proportions rather than absolute values.
Special Considerations
- Ease of Comparison: Common size statements simplify the comparison between companies of different sizes or industries.
- Trend Analysis: They are ideal for performing trend analysis over multiple periods.
- Highlights Proportional Differences: These statements make it easier to identify changes in cost structure or asset distribution.
Examples and Analysis
Example of a Common Size Income Statement
| Item | Amount (in $) | Percentage of Total Revenue |
|---|---|---|
| Total Revenue | 1,000,000 | 100% |
| Cost of Goods Sold | 600,000 | 60% |
| Gross Profit | 400,000 | 40% |
| Operating Expenses | 200,000 | 20% |
| Net Income | 200,000 | 20% |
Example of a Common Size Balance Sheet
| Item | Amount (in $) | Percentage of Total Assets |
|---|---|---|
| Total Assets | 500,000 | 100% |
| Cash | 50,000 | 10% |
| Accounts Receivable | 100,000 | 20% |
| Inventory | 150,000 | 30% |
| Total Liabilities | 200,000 | 40% |
| Equity | 300,000 | 60% |
Historical Context
The use of common size financial statements dates back to traditional financial analysis methods. They are widely used in comparative financial analysis, valuation techniques, and financial modeling.
Applicability
- Internal Analysis: For assessing the performance of different departments or product lines within the same company.
- External Analysis: For comparing the financial health and performance of different companies in the same industry.
- Time-Series Analysis: For observing changes in a company’s financial structure over time.
Comparisons and Related Terms
- Vertical Analysis: Another name for common size analysis, focusing on the proportional size within a single period.
- Horizontal Analysis: This involves comparing financial data over multiple periods, often used alongside vertical analysis for comprehensive insights.
FAQs
Q: How do you calculate a common size income statement? A: Each line item is divided by total revenue and expressed as a percentage.
Q: Why are common size statements useful for investors? A: They provide insights into the structure and efficiency of a company, facilitating better investment decisions.
Q: Can small businesses benefit from using common size financial statements? A: Yes, they can understand their cost structure and make more informed strategic decisions.
References
- Financial Analysis Techniques: “Fundamentals of Financial Management” by James C. Van Horne, John M. Wachowicz Jr.
- Industry Practices: Financial Analysts Journal, various volumes.
Summary
A common size financial statement is a powerful tool in financial analysis that enables easy comparison across companies or different time periods by expressing all items as percentages of a common base figure. This method facilitates deeper insights into financial data, supports trend analysis, and assists in strategic decision-making processes. Whether used internally or for external comparisons, common size financial statements are essential for comprehensive financial analysis.
