Definition
A Common Size Financial Statement is a type of financial document that presents all items in percentage terms. It represents all lines in the income statement as a percentage of sales, and all lines in the balance sheet as a percentage of total assets or total liabilities. This approach makes it easier to compare financial statements of different-sized companies or of the same company over different periods.
Phonetic
The phonetics of “Common Size Financial Statement” is:’kɒmən saɪz fɪˈnænʃəl stəˈteɪmənt
Key Takeaways
Sure, here they are:
- Comparison Across Companies: Common Size Financial Statements normalize figures to provide a percentage-based statement. This makes it possible to compare the financial data of different companies, regardless of their size.
- Time Period Comparison: These statements provide an efficient way to review and compare a company’s performance over different time periods, revealing trends and changes in a company’s financial standing over time.
- Spotlight on Relative Proportions: By expressing each line item as a percentage, common size statements highlight the relative proportions of different components. For instance, you can see how much of the total assets is made up by cash, inventory, etc.
Importance
The Common Size Financial Statement is important in business and finance because it allows for easy comparison across different companies or within different segments of the same company, regardless of their sizes. Essentially, it standardizes financial information by reporting all items as percentages of a common base figure (e.g., sales revenue or total assets). This makes it easier to identify trends, understand company performance, and make meaningful comparisons between sectors, particularly in areas like cost control and profit margins. It is a critical tool for investors, analysts, and managers to interpret financial data and make informed decisions.
Explanation
The main purpose of a Common Size Financial Statement is to allow business owners, investors, and other financial stakeholders to analyze and compare the financial health and performance of a company in a straightforward and efficient manner. These statements, which standardize the figures as a percentage of a certain value, usually total assets for a balance sheet and sales for an income statement, create a larger understanding of the proportional relationships between different components of the financial statement. They offer greater clarity on what percentage each line item or group of line items contributes to the total evaluated figure, providing valuable context that isn’t readily available with simple dollar amounts. Common Size Financial Statements are primarily used for conducting vertical analysis, where each entry is represented as a percentage of the total, facilitating comparison across different companies regardless of their scale. This comparative analysis allows stakeholders to benchmark a company’s performance with industry averages, peers, and even different periods within the company. They are also particularly useful for identifying trends over time and undertaking ratio analysis to deduce the financial ratios concerning liquidity, profitability, and solvency of a company. Ultimately, through the comparative and trend analysis made possible by Common Size Financial Statements, stakeholders can make more informed decisions based on the financial health of the company.
Examples
1. Coca Cola Company: The beverage giant frequently uses Common Size Financial Statements to analyze and compare their financial performance over a certain period. Comparing each item on the balance sheet, income statement, or cash flow statement to a single base figure (like total assets or total sales), helps identify patterns and fluctuation in their financial performance as percentage changes.2. Apple Inc: Apple Inc. also uses Common Size Financial Statements for assessing their financial health and performance. By expressing all items in their financial statements as the percentage of a common base figure, they can easily monitor changes and determine trends, which assists in forecasting their growth and adjusting their corporate strategies to maintain profitability and competitiveness.3. Amazon Inc: Amazon Inc. utilizes Common Size Financial Statements to compare their financial performance with their competitors in the e-commerce industry. By expressing all financial data as a proportion of a common figure from the balance sheet or the income statement, the tech giant gains valuable insights about its position in the market and can make informed decisions to increase its overall efficiency and profitability.
Frequently Asked Questions(FAQ)
What is a Common Size Financial Statement?
A Common Size Financial Statement is a type of financial report that shows all items as percentages of a common base figure. This format is useful to analyze the relative proportion of different financial statement lines items.
Why is a Common Size Financial Statement used?
This statement is used to analyze the changes within a company’s financials over time or compare the financials of different companies.
How is a Common Size Financial Statement created?
For an income statement, each entry is expressed as a percentage of total sales. For a balance sheet, each individual asset, liability, and equity account is expressed as a percentage of total assets.
What types of Common Size Financial Statements are there?
There are three types of Common Size Financial Statements – the Balance Sheet, the Income Statement, and the Cash Flow Statement.
How can Common Size Financial Statements be used in comparative analysis?
Common Size Financial Statements are an invaluable tool for comparative analysis. They standardize financial data, allowing for direct comparison of different companies, irrespective of size.
Will The Common Size Financial Statement Show The Company’s Profitability?
Yes, one can derive key profitability ratios like gross profit margin, net profit margin, etc., from the common size income statement. It also provides insights into cost structure.
Are Common Size Financial Statements used in trend analysis?
Yes, these statements are very effective for identifying trends over time with respect to different line items in percentage terms.
Does it make sense to create a Common Size Financial Statement for small businesses?
Yes, businesses of all sizes can benefit from this type of analysis. It provides a way to review the consistency and financial stability of the business over a particular period.
What is the main disadvantage of a Common Size Financial Statement?
A potential disadvantage of Common Size Financial Statements is that they may oversimplify the data. Large variations in account balances might be overlooked when all items are expressed as a percentage of the total.
Related Finance Terms
- Vertical Analysis
- Balance Sheet
- Income Statement
- Ratio Analysis
- Financial Benchmarking
Sources for More Information
