The Common Size Analysis of Financial Statements

Similarly, every single liability is compared to the overall amount of liabilities, and any equity account is compared to the real value of equity. As a result, each main account classification will equal 100 percent because all minor components will be added to the major account classification. A bank statement is often used by parties outside of a company to gauge the company’s health. When analyzed over time or comparatively against competing companies, managers can better understand ways to improve the financial health of a company. Additional paid-in capital or capital surplus represents the amount shareholders have invested in excess of the common or preferred stock accounts, which are based on par value rather than market price. Shareholder equity is not directly related to a company’s market capitalization.

  1. It is also known as net assets since it is equivalent to the total assets of a company minus its liabilities or the debt it owes to non-shareholders.
  2. Looking at their financial data can reveal their strategy and their largest expenses that give them a competitive edge over other comparable companies.
  3. Share repurchase activity can also be considered a percent of the total top line.

However, if the companies use different accounting methods, any comparison may not be accurate. A common size balance sheet allows for the relative percentage of each asset, liability, and equity account to be quickly analyzed. Likewise, any single liability is compared to the value of total liabilities, and any equity account is compared to the value of total equity. For this reason, each major classification of account will equal 100%, as all smaller components will add up to the major account classification. A typical size balance sheet shows the numeric amount and the relative % for total assets, total liabilities, and equity accounts. Internal and external analysts utilize common-size balance sheets, which are not reporting under generally accepted accounting standards (GAAP).

How Does a Common Size Balance Sheet Differ From a Traditional Balance Sheet?

Recall that a key benefit of common-size analysis is comparing the firm’s performance to the industry. Expressing the figures on the income statement and balance sheet as percentages rather than raw dollar figures allows for comparison to other companies regardless of size differences. On the debt and equity side of the balance sheet, however, there were a few percentage changes worth noting. In the prior year, the balance sheet reflected 55 percent debt and 45 percent equity. In the current year, that balance shifted to 60 percent debt and 40 percent equity.

The firm did issue additional stock and showed an increase in retained earnings, both totaling a $10,000 increase in equity. However, the equity increase was much smaller than the total increase in liabilities of $40,000. The remainder of that increase is seen in the 5 percent increase in current liabilities. One version of the common size cash flow statement expresses all line items as a percentage of total cash flow.

Real-World Example of a Common Size Income Statement

The term “common size” is most often used when analyzing elements of the income statement, but the balance sheet and the cash flow statement can also be expressed as a common size statement. The limitations notwithstanding, a such balance sheet is a powerful tool for gaining insights into a company’s financial health. Combining a balance sheet with other financial statements and industry benchmarks can provide a more comprehensive understanding of a company’s financial position. Hence, understanding the advantages and limitations of a common size balance sheet can help you to make informed investment decisions.

Looking at their financial data can reveal their strategy and their largest expenses that give them a competitive edge over other comparable companies. For example, large drops in the company’s profits in two or more consecutive years may indicate that the company is going through financial distress. Similarly, considerable increases in the value of assets may mean that the company is implementing an expansion or acquisition strategy, potentially making the company attractive to investors. For example, if the value of long-term debt in relation to the total assets value is high, it may signal that the company may become distressed. This balance sheet compares the financial position of the company as of September 2020 to the financial position of the company from the year prior.

A standard size balance sheet enables fast analysis of the relative percentages of each asset, debt, and equity account. 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. Based on the accounting equation, this also equals total liabilities and shareholders’ equity, making either term interchangeable in the analysis. It’s also possible to use total liabilities to indicate where a company’s obligations lie and whether it’s being conservative or risky in managing its debts. This balance sheet also reports Apple’s liabilities and equity, each with its own section in the lower half of the report. The liabilities section is broken out similarly as the assets section, with current liabilities and non-current liabilities reporting balances by account.

Ultimately, positive cash flow from financing activities left the business with a positive cash position of $13,000. In the future, the company can improve by decreasing investment expenditures and increasing revenue from operating activities. A common-size balance sheet is a comparative analysis of a company’s performance over a period. Share repurchase activity can also be considered a percent of the total top line. Debt issuance is another important figure in proportion to the amount of annual sales it helps generate.

What is the Common Size Balance Sheet? (Explained)

The most valuable aspect of a common size balance sheet is that it supports ease of comparability. The common size balance sheet shows the makeup of a company’s various assets and liabilities through the presentation of percentages, in addition to absolute dollar values. 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. Additionally, the relative percentages may be compared across companies and industries. As with the common size income statement analysis, the common size cash flow statement analysis largely relies on total revenue as the base figure.

This common size income statement for IBM shows an R&D expense that averages close to 1.5% of revenues in 2020 and 2021. The common size method is appealing for research-intensive companies because they tend to focus on research and development (R&D) and what it represents as a percent of total sales. By looking at this common size income statement, we can see that the company spent 10% of revenues on research and development and 3% on advertising. Balance sheets allow the user to get an at-a-glance view of the assets and liabilities of the company. As noted above, you can find information about assets, liabilities, and shareholder equity on a company’s balance sheet. If they don’t balance, there may be some problems, including incorrect or misplaced data, inventory or exchange rate errors, or miscalculations.

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These items are calculated as a percentage of sales so they help indicate how much the company uses them to generate overall revenue. The common size strategy from a balance sheet perspective lends insight into a firm’s capital structure and how it compares to its rivals. You can also look to determine an optimal capital structure for a given industry and compare it to the firm being analyzed. You can then conclude whether the debt level is too high, excess cash is being retained on the balance sheet, or inventories are growing too high.

Learn to master common size balance sheets from industry professionals and academics at home with the online financial courses available on the Emeritus platform. These include certificate and diploma courses tailored to meet your learning needs and schedule. The concept of a common-size balance sheet is much the same as that of the common size income statement but here, we take all the line items, on both the asset and liabilities sides as % of total assets. The idea is to eliminate size differences between companies as well as to get an insight into the financial position and capital allocation of the business.

The technique can be used to analyze the three primary financial statements, i.e., balance sheet, income statement, and cash flow statement. In the balance sheet, the common base item to which other line items are expressed is total assets, while in the income statement, it is total revenues. Want to figure out more effective ways to study your company’s financial statements? This powerful tool displays financial data as a percentage, making it easier to spot trends and changes over time. This blog explores the advantages and disadvantages of using a common size balance sheet and provides insights into how to utilize it efficiently for financial analysis.

What Are Recognition criteria of liabilities in balance sheet?

He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. The goodwill level on a balance sheet also helps indicate the extent to which a company has relied on acquisitions for growth. XYZ has stability and better profitability, so seemingly it may be a better long-term alternative. You can also prepare for the other statements, but that would not be as perfect and informative as these two statements could be.

Many computerized accounting systems automatically
calculate common-size percentages on financial statements. On the Clear Lake Sporting Goods’ common-size balance sheet, we see that current assets remained at common size balance sheet 80 percent of total assets from the prior to current year (see Figure 5.25). While the balance in the equipment account did change as a percentage of total assets, equipment remained the same at 20 percent.

IBM’s overall results during the period examined were relatively steady considering the market and the economic conditions of the time. One item of note is the Treasury stock in the balance sheet, which had grown to more than negative 100% of total assets. But rather than act as an alarm, this indicates that the company had been hugely successful in generating cash to buy back shares, far exceeding what it had retained on its balance sheet. A net profit margin is simply net income divided by sales, which is also a common size analysis. Common size analysis can be conducted in two ways, i.e., vertical analysis and horizontal analysis.

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