Common-size financial statements are the financial statements the company prepares by taking a base value for 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 compare with other companies financial statements.
You can compare and get results of different financial periods of the same company or other companies in the same industry.
The main idea of financial statements is to give information about the business. 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.
The formula for calculating the common size statements is as follows:
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 following:
Common size of Account Receivables = Account Receivables/Total Assets
Example of Common size income statement:
| Sales | 1.00 |
| Cost of Goods Sold | 0.7 |
| Taxes | 0.1 |
| Net Income | 0.2 |
Common size statements are generally prepared for company income statements and balance sheets.
You can also prepare for the other statements, but that would not be as perfect and informative as these two statements could be.
Balance sheets and income statements may be prepared by taking the following information.
- Income statement ratios generally prepare by taking total revenue as the base year.
- Balance sheet items may be compared 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 a 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. 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 another period or company’s income statement, you do not need to calculate all the figures because you can compare your percentages.
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. 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 and get your required information quickly because you can compare ratios more easily than figures. The example I have shown to you is called vertical analysis.
Objective and Purposes of Common-Size Financial Statements
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.
The objective and purposes of common-size financial statements are as follows:
- Comparison: One of the main objectives of common-size financial statements is to allow for easy comparison between different financial periods or companies. By presenting all line items as percentages of a common base figure, common-size financial statements make it easy to compare a company’s financial performance over time or to compare the financial performance of different companies within the same industry.
- Analysis: Another objective of common-size financial statements is to facilitate financial analysis. By presenting financial data in a standardized format, common-size financial statements make it easy to identify trends and patterns in a company’s financial performance. This can help analysts identify strengths and weaknesses in a company’s financial position and make informed decisions about future investments or business strategies.
- Decision-making: Common-size financial statements can also facilitate decision-making by providing a clear and standardized picture of a company’s financial position. This can help investors and other stakeholders make informed decisions about investing in a company, lending it money, or providing other forms of support.
- Internal reporting: Common-size financial statements can also be useful for internal reporting within a company. By presenting financial data in a standardized format, common-size financial statements can help managers identify areas of the business that may require further attention or investment and make informed decisions about allocating resources.
- Communication: Finally, common-size financial statements can help communicate a company’s financial position to external stakeholders, such as investors, creditors, and regulators. By presenting financial data in a transparent and standardized format, common-size financial statements can ensure that all stakeholders have a common understanding of a company’s financial position and performance.
Limitations Common Size Financial Statements
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.
While these statements can be useful in analyzing financial performance, they have several limitations that should be considered.
Some of the main limitations of common-size financial statements are as follows:
- Lack of context: Common-size financial statements only show the relative proportions of each line item without providing any context or explanation. With additional information, it can be easier to understand what the numbers mean and what factors drive ratio changes.
- Limited comparability: Common-size financial statements can be useful for comparing a company’s financial performance over time or against industry averages. However, they may differ across companies with different accounting practices or business models.
- Limited usefulness for small businesses: Common-size financial statements may not be very useful for small businesses with limited financial data, as the ratios may not accurately reflect the company’s financial position or performance.
- Potentially misleading: Common-size financial statements can be misleading if used in isolation, as they do not consider other factors that may affect financial performance, such as changes in market conditions, competition, or regulatory environment.
- Potential manipulation: Common-size financial statements can be manipulated by adjusting the base figure or by selectively including or excluding certain line items, making the ratios appear more favorable or less favorable than they are.
- Ignores qualitative factors: Common-size financial statements do not capture qualitative factors, such as management competence, employee morale, or customer satisfaction, which can have a significant impact on a company’s long-term financial performance.
Conclusion:
So there are benefits to preparing common-sized financial statements, but you have to look for their limitations and consider the changes before comparing and taking results.
This way, you can get beneficial information for your business and identify the key areas where you can improve.
