Financial statements are a crucial part of reporting a company’s financial activities. Usually, these statements can show different aspects at a specific date or for a period.
Most companies prepare four reports, usually occurring annually. Some companies also report their activities quarterly or monthly. Each financial statement plays a crucial role to present a different aspect of those operations.
Financial statements present quantitative information. For most investors, this information is enough to evaluate how a company has fared in its operations.
However, these may miss out on qualitative data, which can also be crucial. These financial statements also follow a specific format. While this feature can be helpful in comparability, it can also limit the information provided to investors.
Financial statements also focus on monetary amounts. While it can help focus on the financial aspects of information, it can also limit them. Investors can use tools like ratio analysis to help tackle these issues.
However, it requires more effort from them. Some companies may also use common-size financial statements to enhance the information provided.
These use a different format while reporting the same aspects.
What is a Common Size financial statement?
When preparing financial statements, companies usually include two columns for monetary amounts. These columns represent the current financial period and the one before it.
In some cases, companies may also consist of other columns for comparisons. However, most financial statements follow the same format. As mentioned above, this format is more rigid and does not provide enhanced information.
Comparatively, common-size financial statements can be more helpful. While traditional reports present monetary amounts only, common-size financial statements go beyond that.
These statements also include comparisons provided in a percentage form. In a way, these offer similar benefits that come with ratio analysis. While these statements require additional work, they improve the quality of the information.
Common size financial statements display line items as a percentage of an underlying financial figure. This figure depends on various factors and differs based on a company’s presentation.
On top of that, the financial statement in question also alters the underlying amount used. Companies can prepare common-size financial statements for three crucial financial statements.
These include the balance sheet, income statement, and cash flow statement.
Common-size financial statements are significantly helpful for investors. Some companies may prepare these statements on their own. However, investors can also calculate the percentage forms by themselves.
Using an underlying financial figure as a base, they can perform a ratio analysis for each financial statement line item. Most spreadsheet tools allow investors to prepare a common-size version without challenges.
Common size financial statements significantly enhance comparability. Usually, investors use them to analyze a company over time with its performance.
In some cases, they can also compare it with its competitors or the industry. Doing so can identify trends that raw financial figures may not provide. Common size financial statements are a part of the ratio analysis process performed by investors.
Overall, common-size financial statements are straightforward. These statements present line items as a percentage of an underlying figure.
This figure is usually a common line item in any financial statement. For most investors, the common-size financial statements are crucial for analysis.
Usually, the most important of these financial statements is the common-size income statement.
What is a Common Size Income Statement?
The common size income statement follows the same principle as the other common size financial statements. This statement expresses each line within a traditional income statement as a percentage of revenues or sales. In this case, the underlying figure companies use includes those figures. For most companies, revenues are the primary comparative tool to understand expenses better.
Essentially, the common size income statement is a type of financial ratio analysis. Most investors perform this analysis even when they don’t prepare the common-size income statement.
For example, the net and gross profit margin ratios are similar to this statement. These are also a part of the common-size income statement.
Instead of calculating them individually, investors can use this statement to make the process straightforward.
The common size income statement helps investors in vertical analysis. In this type of analysis, investors represent each item in this statement as a percentage of revenues.
These revenues are a base figure within the income statement. This analysis differs from horizontal analysis, where investors compare the information with the previous year’s information.
Usually, that form of analysis uses the previous year’s figures as a base.
The common size income statement provides insights into a company’s performance for the same period. Moreover, it can also help investors compare that performance to previous years.
For example, they can analyze the percentage of operating expenses relative to revenues. Once they do so, they can compare it for two years to understand how companies handled their operations.
Like other common-size financial statements, the income statement can also be critical for trend analysis. Investors can also compare the calculated percentages externally.
For example, they can check them against a competitor or industry ratios. This analysis helps remove the monetary limitations that come with traditional financial statements.
Investors can compare information relatively, making comparisons between various companies more straightforward.
Overall, the common-size income statement uses the same format as the traditional one. However, it presents information as percentages of revenues.
Companies may show this information alongside the monetary amounts, combining both formats. This statement can help investors analyze revenues, expenses, and profits trends. Moreover, it can enhance the comparison between various aspects significantly.
How to Prepare a Common Size Income Statement?
Preparing the common-size income statement is straightforward. Although it does not present monetary amounts, it still needs them to calculate percentages.
Usually, companies present both aspects in adjacent columns to present how they relate. Similarly, companies must establish their base figure to calculate those percentages.
As mentioned above, this figure is the revenue generated by the company.
Once companies establish their revenues, they can calculate the ratio for each line item using that as a base. Investors can also formulate this information using the traditional income statement if companies don’t present it.
They can use the following formula to prepare the common-size income statement.
Line item / Revenues x 100
For each income statement line item, companies also show the monetary amount. This way, they can provide information for investors to use comparatively.
This formula allows them to present those amounts as percentages. With this information, investors can make further analyses and comparisons. The common-size income statement uses a similar format as the traditional one.
Given below is an example of a common-size income statement. As we could see, it is showing both financial data in US$ and in percentages.
|Income Statement||Common Size Income Statement|
|Cost of sales||($50,000)||50%|
The above example elaborates on how the common size income statement may look. Revenues are the underlying figure used to prepare the common-size version of this statement.
Similarly, the other line items only show the percentage relative to the underlying amount. The above example of a common-size income statement contrasts with the traditional statement.
Common-size financial statements present financial information through percentages. These statements use a common financial figure as a base.
Based on that, it calculates the ratio for line items. The common size income statement uses revenues as that base. For investors, this statement is crucial in comparing a company’s financial performance with others.