Common-size financial statements are the financial statements that are prepared by the company by taking a base value for the purpose of comparison and displaying the result in percentages. These financial statements are prepared for internal purposes rather than for compliance with external stakeholder requirements All the values are expressed in the form of ratios and percentages.
These are easy to understand and easy to compare with other companies’ financial statements.
You can compare and get results of different financial periods of the same company or different companies in the same industry.
The main idea of financial statements is to give information about the business and when to convert the normal financial statements into common-sized statements you can easily compare your assets to liabilities ratio and your gross profit to sales ratio.
The formula for calculating the common size statements as:
Common size % = Required Item/Base Item
For example, if your required item is account receivable and your base item is total assets then you can easily calculate the:
Common size of Account Receivables = Account Receivables/Total Assets
Example of Common size income statement:
|Cost of Goods Sold||0.7|
Common size statements are generally prepared for company income statements and balance sheets.
You can prepare for the other statements also but that would not be as perfect and informative as these two statements could be.
Balance sheet and income statement may be prepared by taking the following information.
- Income statement rations generally prepare by taking total revenue as the base year.
- Balance sheet items may be compare by taking the value of total assets.
Let’s have a look at common size statements.
Common Size Income Statement
A common size income statement is the statement that shows the number of revenues, cost of goods sold, and operating expenses in both value (Ex: USD) and the percentage of each line item compared to total revenues for a specific period of time. The purpose of this statement is to help users have a better understanding of how each item of the income statement contributes to the total revenue.
See the example below:
The value is all determined by comparing each expense with the total sales. You can change your base to whatever you want.
Now if you want to analyze your income statement with some other period or some other company’s income statement. You do not need to calculate all the figures because you can just compare the percentages that you have.
What is the Common Size Balance Sheet?
Common size balance sheet is the balance sheet that prepares by management to show both values of each item in assets, liabilities, and equity in currency (USD) and percentages (%) at the end of the accounting period. By using this statement, users could quickly see the percentage of each item, cash or account receivable, compared to total assets.
See the example below:
Now you can easily compare this balance sheet with another balance sheet and get your required information very easily. Because you can compare ratios more easily than figures. The example I have shown to you is called vertical analysis.
Limitations Common Size Financial Statements
As you have read many benefits of common-size financial statements. There are also some limitations associated.
Different companies use different accounting policies to prepare their normal financial statements and as common size statements are based on normal statements so to get better results you should adjust the values accordingly.
Every firm uses different financial years as convenient to them. So when you want to compare statements of different companies you should also check the time from which the statements belong.
So there are benefits of preparing common-sized financial statements but you have to look for their limitation and think about the changes before comparing and taking results.
In this way, you can get very useful information for your business and identify the key areas where you can improve.