Using Common Size Financial Statements

During the analyzing and interpreting a company’s Income Statement & Balance Sheet, managers might find it difficult to read the figures particularly when you are comparing companies of different sizes ( turnover, assets, depreciation,etc).

However, by using the Common Size methodology to analyze the financial statements (say the Income Statement and Balance Sheet) are extremely useful as it :-

• removes bias particularly when the companies are of differing sizes.
• Common financial statements enable us to do easy analysis between companies or between time periods of a company.
• It allows us to analyze the company over various time periods, revealing, for example, what percentage of sales is cost of goods sold and how that value has changed over time or what percentage of total assets is inventory/receivables and how that value has changed over time.

So what is really common size financial statements? Common size methodology is simply displaying or formatting all items whether in the balance sheet or income statement as percentages of a common base figure.In the case of an income statement, the common base is the revenue whilst in the balance sheet it can be the total assets/total liabilities.
 Common size financial statement is one of the principal tools used in ratio analysis as most firms don’t report their statements in common size, it is beneficial to compute if we want to analyze two or more companies of differing size against each other.
 Let’s look at a simple Income Statement – a normal one and then compared with a Common size : A normal Income Statement:-

 Translated into a Common Size Income Statement

 After the re-format / display into common size income statement, we can see how the various components of the income statement affecting the company’s profit.Line (1) – gross profit have improved from 27.3% in 2005 to 33.3% – why?Line (2) - operating costs also improved from 10% to 6.6% – why?As a result now we know what caused the improvement in operating profit But what is this “ other incomes” under Line 3 from a meager 0.5% have rose to 4.% of total revenues? Is it common for this type of company to have such high other income – is it exceptional re: one time affair which might distort the profit before tax.If we want to delve further, we should go into details into the operating cost (line2) or we can put up a detailed financial statement for inter-companies comparies.Next what about the common size Balance sheet :With a common-size balance sheet that displays all items as percentages of a common base figure like total assets, it assist us to perform analysis between companies or between time periods of a company.Simple Illustration: Normal Balance Sheet

Translated into a Common Size Balance Sheet

 The above illustrates the difference between a regular balance sheet and a common size balance sheet. Salient points: In the normal balance sheet, account values are expressed in dollar terms, while in the common size one, each value is listed as a percentage of total assets.This is also done for liabilities, where each liability account is a percentage of total liabilitiesReviewing the common sized balance sheet, line 1-3 showed a drastic decline of holding cash and more investments into inventory and receivables.

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