18 3: Common-Size Financial Statements Business LibreTexts

It is not another type of income statement but is a tool used to analyze the income statement. Common-size income statements can provide some valuable information to investors and company leaders. However, they may not be enough on their own for a complete analysis of a company’s financial health. In addition to conducting vertical analysis on income statements, investors can also conduct a vertical analysis of a balance statement or a cash flow statement to identify positive or negative trends. 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.

  1. This caused net income to increase as well, from 22.0 percent in 2009 to 33.6 percent in 2010.
  2. As you can see in Figure 13.5 “Common-Size Income Statement Analysis for “, Coca-Cola’s gross margin as a percent of net sales decreased from 2009 to 2010 (64.2 percent versus 63.9 percent).
  3. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

The common size income statement calculator allows for two income statements to be entered so that comparisons can be made. The use of the common size income statement as a comparison tool is discussed more fully in our common size income statement tutorial. Common size financial statement analysis, which is also called a “vertical” analysis, is a technique that financial managers use to analyze their financial statements.

ABC Company’s income statement and vertical analysis demonstrate the value of using common-sized financial statements to better understand the composition of a financial statement. Common-size income statement analysis states every line item on the income statement as a percentage of sales. If you have more than one year of financial data, you can compare income statements to see your financial progress. This type of analysis will let you see how revenues and spending on different types of expenses change from one year to the next.

Since the common-size ratios tell you your business has low in-person sales, you might conduct sales training to help your store employees sell more effectively. Operating profit is one of the most important numbers you can analyze because it shows the health of the business firm’s core business. Cynthia Gaffney has spent over 20 years in finance with experience in valuation, corporate financial planning, mergers & acquisitions consulting and small business ownership. A Southern California native, Cynthia received her Bachelor of Science degree in finance and business economics from USC. The above examples perfectly explain the process of vertical analysis for the companies XYZ Ltd. and ABC Ltd. The financial manager needs this analysis to observe and learn how the company performs to its revenue benchmarks.

Common Size Ratio Analysis For Financial Statements

Common size financial statements help to analyze and compare a company’s performance over several periods with varying sales figures. A common size financial statement displays items as a percentage of a common base figure, total sales revenue, for example. This type of financial statement allows for easy analysis between companies, or between periods, for the same company. However, if the companies use different accounting methods, any comparison may not be accurate. The technique can be used to analyze the three primary financial statements, i.e., balance sheet, income statement, and cash flow statement. 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.

How to Calculate the Common Size Ratio

Ratio analysis can help with the identification of a business’ strengths and weaknesses. 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. From the table above, we calculate that cash represents 14.5% of total assets while inventory represents 12%. If it is declining, which is in the case of XYZ, Inc., there is less money for the shareholders and for any other goals that the firm’s management wants to achieve. It is also watched closely by lenders (e.g., banks) when assessing a company’s credit risk.

Common Size Balance Sheet Defined

Doing so will help you see at a glance which expenses take up the largest percentage of your revenue. The following examples display the companies’ joint size income statement and balance sheet and briefly discuss the format and procedure for solving the ratio. The key benefit of a common size analysis is that it allows for a vertical analysis by line item over a single period, such as quarterly or annually.

Firm of the Future

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. 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. Since from the accounting equation, total assets also equals total liabilities plus equity, the common size balance sheet also shows the percentage each line item has to total liabilities plus equity. When you show the items on the income statement as a percentage of the sales figure, it makes it easier to compare the income and expenses and understand the financial position of the company. Common size analysis is an excellent tool to compare companies of different sizes or to compare different years of data for the same company, as in the example below.

For this reason, each major classification of account will equal 100%, as all smaller components will add up to the major account classification. That is a precipitous decline in one year and, if the company has shareholders, it will leave them questioning what went wrong. It is a clear signal to management that it needs to get a handle on the increasing COGS, as well as the increased sales costs and administrative expenses. If there are any fixed assets that can be sold, management should consider selling them to lower both the depreciation and interest expense on debt.

The income statement (also referred to as the profit and loss (P&L) statement) provides an overview of flows of sales, expenses, and net income during the reporting period. The income statement equation is sales minus expenses and adjustments equals net income. 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, common size percentage but the balance sheet and the cash flow statement can also be expressed as a common size statement. For the balance sheet, the total assets of the company will show as 100%, with all the other accounts on both the assets and liabilities sides showing as a percentage of the total assets number. Common size financial statements help to analyze and compare a company’s performance over several periods with varying sales figures.

Real-World Example of a Common Size Income Statement

He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough https://accounting-services.net/ University. First, the cost of goods sold (COGS) for the business firm has increased from Year 1 to Year 2. The COGS usually includes direct labor costs and the cost of direct materials used in production.

Let’s say that your company was assessing a competitor for potential acquisition, and you compare your firm’s common-size balance sheet alongside that of the target company. You find that the target company has accounts receivable at 45 percent of its total assets, as compared to only 20 percent for your company. Calculating a common-size balance sheet or income statement doesn’t require much, other than a calculator or spreadsheet. You’ll find the usefulness of this technique comes from analyzing and interpreting the results. Common size financial statements make it easier to determine what drives a company’s profits and to compare the company to similar businesses. Each line item on a balance sheet, statement of income, or statement of cash flows is divided by revenue or sales.

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