This is by using proportion rather than the actual numbers as the means of comparison. Although this kind of analysis can be performed on many types of financial statements, the balance sheet and the income statement are most commonly analyzed using this tool. A common size balance sheet is a balance sheet that displays both the numeric value and relative percentage for total assets, total liabilities, and equity accounts. Common size balance sheets are used by internal and external analysts and are not a reporting requirement of generally accepted accounting principles (GAAP). A common size income statement is an income statement in which each line item is expressed as a percentage of the value of revenue or sales.
For example, regardless of a company’s size, the advertising expense should be about 15 percent of sales for a given industry. When comparing any two common size ratios, it is important to make sure that they are computed by using the same base figure. Common Size Analysis can also be performed on the balance sheet, the cash flow statement, and the retained earnings statement. The information a common-sized analysis of the balance sheet can provide analysts was discussed above. Below are some uses of this kind of analysis for the cash-flow statement and the statement of retained earnings. Common size statements are generally prepared for company income statements and balance sheets.
Analyzing Organizational Performance
In the short term, a company’s executives can compare the firm’s percentages to the industry’s average percentages. They can also use the common-size balance sheet’s information to review their long-term assets and liabilities, and address any significant changes. Similar to an income statement analysis, many items in the cash flow statement can be stated as a percent of total sales. This can give insight into several cash flow items, including capital expenditures (CapEx) as a percent of revenue.
However, the equity increase was much smaller than the total increase in liabilities of $40,000. The remainder of that increase is seen in the how to calculate percentage in common size balance sheet 5 percent increase in current liabilities. Likewise a similar process to that used above can be applied to compare two different businesses.
Objective and Purposes of Common-Size Financial Statements
You may also notice the first row, which is net income as a percent of total sales—matches precisely with the common size analysis from an income statement perspective. For example, the accounts receivables has increased from 57,263 to 112,637 over the two periods. The common size balance sheets, however, shows that as a proportion of total assets accounts receivable has remained fairly constant at 27.7% and 27.2% of total assets.
You can also prepare for the other statements, but that would not be as perfect and informative as these two statements could be. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
To make comparisons of the business with other businesses irrespective of their relative size
Clear Lake Sporting Goods, for example, might compare their financial performance on their income statement to a key competitor, Charlie’s Camping World. Charlie is a much bigger retailer for outdoor gear, as Charlie has nearly seven times greater sales than Clear Lake. Common-size statements allow Clear Lake to compare their statements in a meaningful way (see Figure 5.26).
Common size analysis is a technique that is used to analyze and interpret the financial statements. Thus, this technique helps in assessing the financial statements by considering each line item as a percentage of the base amount for that period. This can be used on the balance sheet to determine how cash compares to total assets. If cash is $406,062 and total assets are $1,163,028, then the common size percentage is 35%.
We’ll start by inputting our historical income statement and balance sheet into an Excel spreadsheet. By dividing the net difference by the base figure, the percentage change comes out to 25%. 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. As can be seen in the example above the two business are in two very different industries and the balance sheet analysis clearly highlights the differences irrespective of their relevant size.
- Recall that a key benefit of common-size analysis is comparing the firm’s performance to the industry.
- One version of the common size cash flow statement expresses all line items as a percentage of total cash flow.
- The current assets formula determines that the “total current assets,” which are the total of all assets that can be converted to cash within one year, makes up 37% of the company’s total assets.
- Unless explained in the notes, this drastic change will merit a serious investigation.
This type of analysis is used to analyze a company’s financial statements to identify patterns and trend lines, and to compare a company against competitors. When figures are expressed as a percentage of a whole, analysts can assess how each part contributes relative to another. In income statements, line items are most often divided by total revenues or total sales. If Company A had $2,000 in operating expenses and $4,000 in total revenues, the operating expenses would be presented as 50%. Vertical analysis expresses each line item on a company’s financial statements as a percentage of a base figure, whereas horizontal analysis is more about measuring the percentage change over a specified period.
Liquidity refers to how quickly an asset can be turned into cash without affecting its value. For this reason, the top line of the financial statement would list the cash account with a value of $1 million. A common size balance sheet is one that has an additional column showing each monetary amount as a percentage of the total assets of the business.