18 3: Common-Size Financial Statements Business LibreTexts

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A balance sheet explains the financial position of a company at a specific point in time. As opposed to an income statement which reports financial information over a period of time, a balance sheet is used to determine the health of a company on a specific day. The balance sheet includes information about a company’s assets and liabilities. Depending on the company, this might include short-term assets, such as cash and accounts receivable, or long-term assets such as property, plant, and equipment (PP&E). Likewise, its liabilities may include short-term obligations such as accounts payable and wages payable, or long-term liabilities such as bank loans and other debt obligations.

Accounts within this segment are listed from top to bottom in order of their liquidity. They are divided into current assets, which can be converted to cash in one year or less; and non-current or long-term assets, which cannot. The Profit & Loss statement gives an idea about the profitability of a business. In fact, some sources of industry data present the information exclusively in a common-size format, and most of the accounting software available today has been engineered to facilitate this type of analysis. ABC’s profitability may be lower, but its cash generation abilities cannot be questioned and so bankruptcy risk will be minimal and there will be no shortage of investors trying to get in on the action. And there is no reason ABC cannot reach XYZ’s labor costs over time, which would immediately drive profits up.

1. Furthermore, the common size income statement does not showcase trends of each of the line items.
2. When converting standard financial statements into common-sized statements, you can easily compare your assets to liabilities ratio and your gross profit to sales ratio.
3. This common size income statement analysis is done on both a vertical and horizontal basis.
4. The firm did issue additional stock and showed an increase in retained earnings, both totaling a $10,000 increase in equity.

This is a significant difference that would be an indicator that Clear Lake and Charlie have key differences in their operations, purchasing policies, or general performance in their core products. One company may be willing to sacrifice margins for market share, which would tend to make overall sales larger at the expense of gross, operating, or net profit margins. IBM’s cash flow statement in terms of total sales indicates that it generated an impressive level of operating cash flow, averaging 26.9%% of sales over the three-year period. Net income represents 10% 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 Excel, sometimes we need to create a common-size income statement in Excel. But here we will calculate the relative percentage with respect to the Total Revenue instead of Total Assets.

Additional paid-in capital or capital surplus represents the amount shareholders have invested in excess of the common or preferred stock accounts, which are based on par value rather than market price. Shareholder equity is not directly related to a company’s market capitalization. The latter is based on the current price of a stock, while paid-in capital is the sum of the equity that has been purchased at any price. As noted above, you can find information about assets, liabilities, and shareholder equity on a company’s balance sheet.

If Company A had $2,000 in operating expenses and $4,000 in total revenues, the operating expenses would be presented as 50%. 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 this reason, the top line of the financial statement would list the cash account with a value of $1 million. Although the balance sheet is an invaluable piece of information for investors and analysts, there are some drawbacks.

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. The only difference is that each line item on this accounting balance sheet is expressed as a percentage of total assets.

What is Common Size Statement Analysis?

Hence, understanding the advantages and limitations of a common size balance sheet can help you to make informed investment decisions. Learn to master common size balance sheets from industry professionals and academics at home with the online financial courses available on the Emeritus platform. These include certificate and diploma courses tailored to meet your learning needs and schedule. Common-size financial statements are financial statements that present all items as percentages of a common base figure, such as total assets or total revenue. 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.

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With the help of a Comparative Common-size Balance Sheet of different periods, one can highlight the trends in different items. If a Common-size Balance Sheet is prepared for the industry, it facilitates the assessment of the relative financial soundness and helps in understanding the financial strategy of the organisation. The common-size balance sheet functions much like the common-size income statement. Each line item on the balance sheet is restated as a percentage of total assets. A company could benchmark its financial position against that of a best-in-class company by using common size balance sheets to compare the relative amounts of their assets, liabilities, and equity.

Balance Sheet Analysis

They can see this breakdown for each firm and compare how different firms function in terms of expenses, proportionally. They can also look at the percentage for each expense over time to see if they are spending more or less on certain areas of the business, such as research and development. On the balance sheet, analysts commonly look to see the percentage of debt and equity to determine capital structure. They can also quickly see the percentage of current versus noncurrent assets and liabilities. Financial statements that show only
percentages and no absolute dollar amounts are common-size statements.

This caused net income to increase as well, from 22.0 percent in 2009 to 33.6 percent in 2010. In the expense category, cost of goods sold as a percent of net sales increased, as did other operating expenses, interest expense, https://personal-accounting.org/ and income tax expense. Selling and administrative expenses increased from 36.7 percent in 2009 to 37.5 percent in 2010. This common size income statement analysis is done on both a vertical and horizontal basis.

For this reason, a balance alone may not paint the full picture of a company’s financial health. The term balance sheet refers to a financial statement that reports a company’s assets, liabilities, and shareholder equity at a specific point in time. Balance sheets provide the basis for computing rates of return for investors and evaluating a company’s capital structure. One version of the common size cash flow statement expresses all line items as a percentage of total cash flow. A common-size financial statement displays line items as a percentage of one selected or common figure. Creating common-size financial statements makes it easier to analyze a company over time and compare it to its peers.

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. Now, if you want to analyze your income statement with another period or company’s income statement, you do not need to calculate all the figures because you can compare your percentages. 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.

Where horizontal analysis looked at one
account at a time, vertical analysis will look at one YEAR at a
time. The balance sheet common size analysis mostly uses the total assets value as the base value. A financial manager or investor can use the common size analysis to see how a firm’s capital structure compares to rivals. They can make important observations by analyzing specific line items in relation to the total assets. In income statements, line items are most often divided by total revenues or total sales.

Coca-Cola’s gross margin is 63.9 percent of net sales compared to 54.1 percent at PepsiCo. Coca-Cola’s operating income is 24.1 percent of sales compared to 14.4 percent at PepsiCo. Figure 13.8 compares common-size gross margin and operating income for Coca-Cola and PepsiCo. In general, managers prefer expenses as a percent of net sales to decrease over time, and profit figures as a percent of net sales to increase over time. As you can see in Figure 13.5, Coca-Cola’s gross margin as a percent of net sales decreased from 2009 to 2010 (64.2 percent versus 63.9 percent). Income before taxes increased significantly from 28.6 percent in 2009 to 40.4 percent in 2010, again mainly due to a one-time gain of $4,978,000,000 in 2010.

He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.