The Common-Size Analysis of Financial Statements

A common size balance sheet is a refined version of the balance sheet itself, but also includes each single line item as a percentage of total assets, liability and equity apart from the conventional numeric value. Many items in the cash flow statement can be stated as a percent of total sales, similar to an income statement analysis. This can give insight into several cash flow items, including capital expenditures (CapEx) as a percent of revenue. You can see that long-term debt averages around 34% of total assets over the two-year period, which is reasonable. Cash ranges between 5% and 8.5% of total assets and short-term debt accounts for about 5% of total assets over the two years.

1. In Figure 5.21, you can see the formulas used to create Clear Lake Sporting Goods’ common-size income statement in Excel.
2. Due to the huge differences in the asset size, the traditional way of comparing the absolute numeric figures would not be an accurate approach.
3. The same process would apply on the balance sheet but the base is total assets.
4. Using this statement, users could quickly see the percentage of each item, cash or account receivable, compared to total assets.
5. This makes it easier to compare figures from one period to the next, compare departments within an organization, and compare the firm to other companies of any size as well as industry averages.

The use of common-size statements facilitates vertical analysis of a company’s financial statements. While common size balance sheets are not a requirement of generally accepted accounting principles (GAAP), they offer a number of benefits to both internal and external parties. While most firms do not report their statements in common size format, it is beneficial for analysts to do so to compare two or more companies of differing size or different sectors of the economy. Formatting financial statements in this way reduces bias that can occur and allows for the analysis of a company over various periods.

As the common-size balance-sheet reports the assets first in the order of liquidity, the top entry would be of Cash worth $2 million. Apart from this, it would also report the composition of this cash as a percentage of total assets, i.e. 20% ($2 million divided by $10 million). On the debt and equity side of the balance sheet, however, there were a few percentage changes worth noting. 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.

To analyze changes in the balance sheet of the business over time

For this reason, the top line of the financial statement would list the cash account with a value of $1 million. Common-size financial statements are the financial statements the company prepares by taking a base value for comparison and displaying the result in percentages. These financial statements are prepared for internal purposes rather than for compliance with external stakeholder requirements. Since we use net sales as the base on the income statement, it tells us how every dollar of net sales is spent by the company. For Synotech, Inc., approximately 51 cents of every sales dollar is used by cost of goods sold and 49 cents of every sales dollar is left in gross profit to cover remaining expenses. Of the 49 cents remaining, almost 35 cents is used by operating expenses (selling, general and administrative), 1 cent by other and 2 cents in interest.

Real-World Example of a Common Size Income Statement

All three of the primary financial statements can be put into a common-size format. Financial statements in dollar amounts can easily be converted to common-size statements using a spreadsheet. On the other hand, solvency refers to a company’s ability to meet its financial obligations over the longer term. As such, solvency emphasizes the company’s financial framework and its capacity to service long-term debts.

Many computerized accounting systems automatically calculate common-size percentages on financial statements. On the Clear Lake Sporting Goods’ common-size balance sheet, we see that current assets remained at 80 percent of total assets from the prior to current year (see Figure 5.25). While the balance in the equipment account did change as a percentage of total assets, equipment remained the same at 20 percent. It is convenient to build a common size balance sheet as it helps in building trend lines to discover the patterns over a specific period. In short, it is not just an upgraded variety of the balance sheet per se, but it also captures each single line item as a percentage of total assets, total liabilities and total equity besides the usual numeric value.

Two primary methods for common-sizing the balance sheet are vertical common-size analysis and horizontal common-size analysis. While these statements can be useful in analyzing financial performance, they have several limitations that should be considered. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals common size balance sheet format can learn and propel their careers. The goodwill level on a balance sheet also helps indicate the extent to which a company has relied on acquisitions for growth.

Chapter 2: Reconstitution of a Partnership Firm: Change in Profit Sharing Ratio

Let’s look at the common size vertical format balance sheet of Sundaram Pipes, Fittings and Motor Pumps. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own.

Example: Vertical Common-size Analysis (Cross-Sectional Analysis Analysis)

There is no mandatory format for a common size balance sheet, though percentages are nearly always placed to the right of the normal numerical results. If you are reporting balance sheet results as of the end of many periods, you may even dispense with numerical results entirely, in favor of just presenting the common size percentages. Likewise a similar process to that used above can be applied to compare two different businesses. For example, the common size balance sheets below are for two different businesses of differing sizes. Accordingly by producing a balance sheet at the end of each accounting period, it is possible to monitor changes in each line item over time. For example, the following shows the vertical common size analysis for two accounting periods.

Each line item on a balance sheet, statement of income, or statement of cash flows is divided by revenue or sales. You might be able to find them on the websites of companies that specialize in financial analysis. 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%. For Example, Company A has $10 million in total assets, $7 million in total liabilities and $3 million in total equity.

1. When figures are expressed as a percentage of a whole, analysts can assess how each part contributes relative to another.
2. A Common-size Balance Sheet represents all line items, on both asset and liabilities sides, as a % of total assets.
3. In this next section we will explore the requirements for what needs to be reported, when, and to whom.
4. On the other hand, solvency refers to a company’s ability to meet its financial obligations over the longer term.
5. The basic objective of a Common-size Balance Sheet is to analyse the changes in the individual items of a Balance Sheet.
6. Although common-size balance sheets are most typically utilized by internal management, they also provide useful information to external parties, including independent auditors.

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It’s important to add short-term and long-term debt together and compare this amount to the total cash on hand in the current assets section. This lets you know how much of a cash cushion is available or if a firm is dependent on the markets to refinance debt when it comes due. The effectiveness of cross-sectional financial ratio analysis can be constrained by variations in accounting practices. Furthermore, comparability can be hindered by the lack of uniformity in a company’s operational activities.

These are easy to understand and compare with other companies financial statements. Additionally our common size balance sheet calculator is available and can be used to make the calculations and comparisons referred to above. A common-size analysis is unlikely to provide a comprehensive and clear conclusion on a company on its own. A short-term drop in profitability could indicate just a speed bump rather than a permanent loss in profit margins. It is also prepared to see the trends of different items of assets, equity and liabilities of a Balance Sheet.