Common Size Analysis
Common Size Statements are used to compare financial statements of different-size companies, or of the same company over different periods. Common-size analysis – (also called vertical analysis) expresses each line item on a single year’s financial statement as a percent. The base amount for the balance sheet is usually total assets (which is the same number as total liabilities plus stockholders’ equity), and for the income statement it is usually net sales or revenues. By comparing two or more years of common-size statements, changes in the mixture of assets, liabilities, and equity become evident.
On the income statement, changes in the mix of revenues and in the spending for different types of expenses can be identified The ratios often are expressed as percentages of the reference amount. Common size statements usually are prepared for the income statement and balance sheet, expressing information as follows: * Income statement items – expressed as a percentage of total revenue * Balance sheet items – expressed as a percentage of total assets Comparisons Between Companies (Cross-Sectional Analysis)
A company may choose to utilize financial statements of this type to present a quick snapshot of how much of the company’s collected or generated revenue is going toward each operational function within the organization.
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The use of a common-size statement can make it possible to quickly identify areas that may be utilizing more of the operating capital than is practical at the time, and allow budgetary changes to be implemented to correct the situation. The common size statement can also be a helpful tool in comparing the financial structures and operation strategies of two different companies.
The use of percentages in the common size statements removes the issue of which company generates more revenue, and brings the focus on how the revenue is utilized within each of the two businesses. Often, the use of a common-size statement in this manner can help to identify areas where each company is utilizing resources efficiently, as well as areas where there is room for improvement. Common-size statements can be prepared for any review period desired. Companies that choose to make use of financial statements of this type may choose to utilize this format for quarterly, semi-annual, or annual reviews.