Common Size Analysis of Financial Statements

This firm may have purchased new fixed assets at the wrong time since its COGS was rising during the same period. In income statements, line items are most often divided by total revenues or total sales. If Company A https://personal-accounting.org/common-size-balance-sheet/ had $2,000 in operating expenses and $4,000 in total revenues, the operating expenses would be presented as 50%. Notice that PepsiCo has the highest net sales at $57,838,000,000 versus Coca-Cola at $35,119,000,000.

It is also watched closely by lenders (e.g., banks) when assessing a company’s credit risk. Doing so will help you see at a glance which expenses take up the largest percentage of your revenue. As of your balance sheet date, A/R represents 15 percent of total assets. Common Size Analysis can also be performed on the balance sheet, the cash flow statement, and the retained earnings statement. The information a common-sized analysis of the balance sheet can provide analysts was discussed above.

What is a Common Size Balance Sheet?

Whenever you analyze your margins — gross profit, net profit or operating — you’re performing a common size analysis. While common size balance sheets are not a requirement of generally accepted accounting principles (GAAP), they offer a number of benefits to both internal and external parties. As with the common size income statement analysis, the common size cash flow statement analysis largely relies on total revenue as the base figure. Here, you’ll render items on your cash flow statement as a percentage of net revenue. This analysis lets you see how effectively you’re leveraging the cash in your business, beyond just dollars flowing into and out of your bank account.

The following example of company XYZ’s income statement and revenue and expense calculations helps you understand how common size income statement analysis works. 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. Let’s say that your company was assessing a competitor for potential acquisition, and you compare your firm’s common-size balance sheet alongside that of the target company.

Interpretation of a Financial Statement

One reason the cost of goods sold has gone up is that sales have gone up, but here is an important distinction. This tool is especially important if you’re using key performance indicators to measure your business’s performance and profitability. The approach lets you compare your business to your competitors’ businesses, regardless of size differences.

• The next point of the analysis is the company’s non-operating expenses, such as interest expense.
• As of your balance sheet date, A/R represents 15 percent of total assets.
• This affords the ability to quickly compare the historical trend of various line items or categories and provides a baseline for comparison of two firms of different market capitalizations.
• To express the amounts as the percentage of the total, the total assets or total equity and liabilities are taken as 100.
• The basic objective of a Common-size Balance Sheet is to analyse the changes in the individual items of a Balance Sheet.

Common-size balance sheet analysis helps management gain quick insight into the fluctuations in the company’s assets and liabilities, and gives management an opportunity to spot potential issues before the issues become problems. Performing common-size calculations for several different time periods and looking for trends can be especially useful. First, the percentages for each line item are compared over a period of time, to discern trends that management can act upon. For example, an increase in the cost of goods sold percentage might call for changes in price points or more attention to supplier costs. Second, the financial statements of competitors can be converted into the common size format, which makes them comparable to a company’s own financial statements. One can then determine how the cost structure or asset base of a competitor varies from the company’s.

What a Common Size Income Statement Analysis Does

Many computerized accounting systems automatically calculate common-size percentages on financial statements. Since we use net sales as the base on the income statement, it tells us how every dollar of net sales is spent by the company. For Synotech, Inc., approximately 51 cents of every sales dollar is used by cost of goods sold and 49 cents of every sales dollar is left in gross profit to cover remaining expenses. Of the 49 cents remaining, almost 35 cents is used by operating expenses (selling, general and administrative), 1 cent by other and 2 cents in interest. We earn almost 11 cents of net income before taxes and over 7 cents in net income after taxes on every sales dollar.

You find that the target company has accounts receivable at 45 percent of its total assets, as compared to only 20 percent for your company. For each line item on this sample income statement, we’ve shown the percentage that it makes up of total revenue. If you just looked at numbers, it might seem like this company did better in 2022 because sales increased from $500,000 to $600,000.

Chapter 12: Financial Statement Analysis

The importance of common size analysis lies in the power of percentages to help you gain a deeper understanding of your business, find out whether it’s growing profitably and compare it to the competition. You can use it to see how your business stacks up percentage-wise with another business, even if that business is substantially larger. An investor may analyze the income statement and discover that research and development expenses increased from 5% of sales to 15% over the last year. Based on this, they may decide that the company has big plans for the future and buy-in, or that they are profligate spendthrifts, unable to keep costs down and sell. As you can see from Figure 13.6 “Common-Size Balance Sheet Analysis for “, the composition of assets, liabilities, and shareholders’ equity accounts changed from 2009 to 2010. In general, you can prepare a common-size income statement by going line-by-line and dividing each expense as a percentage of sales.

If you have more than one year of financial data, you can compare income statements to see your financial progress. This type of analysis will let you see how revenues and spending on different types of expenses change from one year to the next. Company management often analyzes financial statement data to understand how the business is performing relative to where it was historically, and relative to where it wants to go in the future.

Common-size analysis enables us to compare companies on equal ground, and as this analysis shows, Coca-Cola is outperforming PepsiCo in terms of income statement information. However, as you will learn in this chapter, there are many other measures to consider before concluding that Coca-Cola is winning the financial performance battle. The income from selling the products or services will show up in operating profit. If it is declining, which is in the case of XYZ, Inc., there is less money for the shareholders and for any other goals that the firm’s management wants to achieve.

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, and income tax expense. Selling and administrative expenses increased from 36.7 percent in 2009 to 37.5 percent in 2010.

Common size balance sheet example

Conducting a common size balance sheet analysis can let you quickly see how your assets and liabilities stack up. Ideally, you want a low liability-to-asset ratio, as this indicates you will be able to easily pay your business’s obligations. This low ratio is favorable especially if you’re applying for a business loan, since lenders want to be assured that you’re financially solvent enough to take on and repay additional debt.