Common Size Financial Statements

The base item in the income statement is usually the total sales or total revenues. Common size analysis is used to calculate net profit margin, as well as gross and operating margins. The ratios tell investors and finance managers how the company is doing in terms of revenues, and can be used to make predictions of future revenues and expenses.

On the other hand, horizontal analysis refers to the analysis of specific line items and comparing them to a similar line item in the previous or subsequent financial period. Although common size analysis is not as detailed as trend analysis using ratios, it does provide a simple way for financial managers to analyze financial statements. 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. We earn almost 11 cents of net income before taxes and over 7 cents in net income after taxes on every sales dollar.

Horizontal and Vertical Analysis

The most frequent common size financial statements include the likes of the cash flow statement, the income statement, and the balance sheet. Essentially, it allows data entries to be listed as a percentage of a common base figure. This is instead of a traditional financial statement that would list items as absolute numerical figures.

An important feature of common size income statements is that by using ratios rather than dollar figures, it’s possible to compare companies of very different sizes. So a $10 million company’s cost ratio or profit margin can be compared with those of a $100 million company. A common size statement analysis lists items as a percentage of a common base figure. Creating financial statements in this way can make it much easier when it comes to comparing companies, or even comparing periods for the same company. It generated an impressive level of operating cash flow that averaged 26.9%% of sales over the three-year period. 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.

Vertical vs. horizontal common size analysis

The process of creating a common size financial statement is known as common-size analysis or vertical analysis. It starts with total sales or total revenue, also known as the top line of the income statement. All subsequent amounts, such as expenses and profit, are expressed as lesser percentages because their dollar amounts are less than revenue. In rare cases, however, when expenses exceed revenue, the percentage would top 100%. 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.

Unless explained in the notes, this drastic change will merit a serious investigation. The ratios in common size statements tend to have less variation than the absolute values themselves, and trends in the ratios can reveal important changes in the business. Historical comparisons can be made in a time-series analysis to identify such trends.

Common-size financial statements facilitate the analysis of financial performance by converting each element of the statements to a percentage. 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. On the income statement, analysts can see how much of sales revenue is spent on each type of expense.

It looks across the rows of its income statement, from Year 1 to Year 3, its most recent year reported above. The common size balance sheet reports the total assets first in order of liquidity. Liquidity refers to how quickly an asset can be turned into cash without affecting its value.

For example, if the cost of goods sold was $50,000 then you would divide it by $100,000 to equal 50%. It’s worth noting that calculating a company’s margins and the common size calculation are the same. To find the net profit margin, you simply divide net income by sales revenue. With this in mind, read on as we take a look at exactly what a common size financial statement is. As well as lay out the formula for you, describe the different types, and show you the limitations of common size analysis.

How to Use Common Size Financial Statements

However, a more popular version breaks down cash flow in a different way and expresses line items in terms of cash flows from operations. It will also include total financing cash flows and total investing cash flows for both of those activities. Before breaking down the different types of common size analysis, it’s worth understanding that it can be conducted in two ways. Doing so will help you see at a glance which expenses take up the largest percentage of your revenue.

All you need to have is the percentage of the base amount, the total amount of an individual item, and the amount of the base item. Essentially, it helps evaluate financial statements by expressing the line items as a percentage of the amount. It helps break down the impact that each item on the financial statement hro relationship mgr ii in salem, nh, us at adp has, as well as its overall contribution. In IBM’s case, its results overall during the period examined were relatively steady, considering the market and economic conditions of the time. One item of note is the Treasury stock in the balance sheet, which had grown to more than negative 100% of total assets.

Overview of Common Size Financial Statements

He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Vertical analysis is especially helpful in
analyzing income statement data such as the percentage of cost of
goods sold to sales. Where horizontal analysis looked at one
account at a time, vertical analysis will look at one YEAR at a
time. Analysts also use vertical analysis of a single financial statement, such as an income statement.

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All
percentage figures in a common-size balance sheet are
percentages of total assets while all the items in a
common-size income statement are percentages of net
sales. The use of common-size statements facilitates
vertical analysis of a company’s financial statements. Financial statements that show only percentages and no absolute dollar amounts are common-size statements. All percentage figures in a common-size balance sheet are percentages of total assets while all the items in a common-size income statement are percentages of net sales. The use of common-size statements facilitates vertical analysis of a company’s financial statements. Common-size financial statements present the financial statement amounts as a percentage of a base number.

The same formula can be copied and replicated in each income statement line, making the calculations much faster. In Figure 5.21, you can see the formulas used to create Clear Lake Sporting Goods’ common-size income statement in Excel. Notice that the $ can be inserted to anchor a cell reference, making it easier to copy and paste the same formula onto many lines or columns.

What are the Benefits of Common Size Analysis?

For example, a small retailer can compare her cost of goods sold (perhaps 78%) to a much larger retailer’s cost of goods sold (perhaps 80%). Similarly, one company’s inventory might be 33% (of total assets) while a competitor’s might be 28%. A company has $8 million in total assets, $5 million in total liabilities, and $3 million in total equity.

• However, a simple tool like Microsoft Excel can be quite handy in making the process easier and faster.
• This enables you to more easily observe trends in specific metrics and, in turn, adjust the business’ strategy in order to arrive at a more optimal outcome.
• Below is an overview of each financial statement and a more detailed summary of the benefits and drawbacks that such an analysis can provide to you.

A common size balance sheet allows for the relative percentage of each asset, liability, and equity account to be quickly analyzed. Likewise, any single liability is compared to the value of total liabilities, and any equity account is compared to the value of total equity. For this reason, each major classification of account will equal 100%, as all smaller components will add up to the major account classification. It also shows the impact of each line item on the overall revenue, cash flow or asset figures for your company.