13 3: Common-Size Analysis of Financial Statements Business LibreTexts

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.

  1. Furthermore, the stakeholders can undertake analysis by evaluating each of the line item in the balance sheet in relation to the total assets.
  2. However, as you will learn in this chapter, there are many other measures to consider before concluding that Coca-Cola is winning the financial performance battle.
  3. 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.
  4. Charlie is a much bigger retailer for outdoor gear, as Charlie has nearly seven times greater sales than Clear Lake.
  5. This is an open-access Excel template in XLSX format that will be useful for anyone who wants to work as an accountant, financial analyst, or finance manager.

COGS divided by $100,000 is 50%, operating profit divided by $100,000 is 40%, and net income divided by $100,000 is 32%. As we can see, gross margin is 50%, operating margin is 40%, and the net profit margin is 32%–the common size income statement figures. It’s important to note that the common size calculation is the same as calculating a company’s margins. The net profit margin is simply net income divided by sales revenue, which happens to be a common-size analysis.

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). Notice that Clear Lake spends 50 percent of its sales on cost of goods sold while Charlie spends 59 percent.

They can make important observations by analyzing specific line items in relation to the total assets. The next point of the analysis is the company’s non-operating expenses, such as interest expense. This firm may have purchased new fixed assets at the wrong time since its COGS was rising during the same period. Thus, this analysis helps in knowing the effect of each of the items in the financial statements.

We earn almost 11 cents of net income before taxes and over 7 cents in net income after taxes on every sales dollar. This is a little easier to understand than the larger numbers showing Synotech earned $762 million dollars. Recall that a key benefit of common-size analysis is comparing the firm’s performance to the industry.

Income Statement Common Size Analysis

Common size financial statements reduce all figures to a comparable figure, such as a percentage of sales or assets. Each financial statement uses a slightly different convention in standardizing figures. One of the benefits of using common size analysis is that it allows investors to identify large changes in a company’s financial statements. It mainly applies when the financials are compared over a period of two or three years.

How a Common-Size Income Statement Works

Common size balance sheets are similar to rejection letter for grant request​s. The only difference is that each line item on this accounting balance sheet is expressed as a percentage of total assets. As with the common size income statement analysis, the common size cash flow statement analysis largely relies on total revenue as the base figure. Here, you’ll render items on your cash flow statement as a percentage of net revenue. This analysis lets you see how effectively you’re leveraging the cash in your business, beyond just dollars flowing into and out of your bank account. To perform a common size income statement analysis, you’ll compare every line on your profit and loss statement to your total revenue.

The use of common-size statements facilitates vertical analysis of a company’s financial statements. 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. This analysis reveals, for example, what percentage of sales is the cost of goods sold and how that value has changed over time. Common size financial statements commonly include the income statement, balance sheet, and cash flow statement.

The income from selling the products or services will show up in operating profit. 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. The cash flow statement shows how a company generated and spent cash throughout a given timeframe.

Generally accepted accounting principles (GAAP) are based on consistency and comparability of financial statements. A common size income statement makes it easier to see what’s driving a company’s profits. The common size percentages also help to show how each line item or component affects the financial position of the company. As a result, the financial statement user can more easily compare the financial performance to the company’s peers. A common size financial statement displays items as a percentage of a common base figure, total sales revenue, for example.

In the case of XYZ, Inc., operating profit has dropped from 17% in Year 1 to 7.6% in Year 2. The cost of goods sold dropped, while both selling and administrative expenses and depreciation rose. The firm may have bought new fixed assets and/or sales commissions may have increased due to hiring new sales personnel.

Example of a Common Size Income Statement

The common size percentages can be subsequently compared to those of competitors to determine how the company is performing relative to the industry. 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.

Conducting a common size balance sheet analysis can let you quickly see how your assets and liabilities stack up. Ideally, you want a low liability-to-asset ratio, as this indicates you will be able to easily pay your business’s obligations. This low ratio is favorable especially if you’re applying for a business loan, since lenders want to be assured that you’re financially solvent enough to take on and repay additional debt.

The firm did issue additional stock and showed an increase in retained earnings, both totaling a $10,000 increase in equity. However, the equity increase was much smaller than the total increase in liabilities of $40,000. Long-term debt increased by only $10,000 by issuing additional notes payable. The remainder of that increase is seen in the 5 percent increase in current liabilities.

Debt issuance is another important figure in proportion to the amount of annual sales it helps generate. These items are calculated as a percentage of sales so they help indicate how much the company uses them to generate overall revenue. Net income represents 10% https://simple-accounting.org/ of total revenues, and this margin can be compared to the previous year’s margin to see the company’s year-over-year performance. In general, you can prepare a common-size income statement by going line-by-line and dividing each expense as a percentage of sales.

What Is Meant by Common Size Balance Sheet?

Common size vertical analysis lets you see how certain figures in your business compare with a selected figure in one given time period. For example, you might use it to see what percentage of your income is used to support each business expense. You can use it to see how your business stacks up percentage-wise with another business, even if that business is substantially larger.

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