Common Size Financial Statement
Table of Contents
Introduction
When it comes to analyzing financial statements, there are various tools and techniques that can be used to gain valuable insights into a company's performance. One such tool is the Common Size Financial Statement, which provides a way to compare the financial data of different companies or different periods within the same company. In this article, we will explore what a Common Size Financial Statement is, how it is prepared, and how it can be used to make informed financial decisions.
What is a Common Size Financial Statement?
A Common Size Financial Statement is a financial statement that presents all items as a percentage of a base figure, typically sales or total assets. By expressing each line item as a percentage, it allows for easy comparison between companies of different sizes or between different periods within the same company. This technique is particularly useful when analyzing the financial performance of companies operating in different industries or when comparing a company's performance over time.
Preparing a Common Size Financial Statement
To prepare a Common Size Financial Statement, the following steps are typically followed:
- Step 1: Choose a base figure: The first step in preparing a Common Size Financial Statement is to choose a base figure. This base figure is usually either sales or total assets. Choosing the right base figure depends on the purpose of the analysis and the specific insights you are looking to gain.
- Step 2: Calculate the percentage: Once the base figure is chosen, each line item on the financial statement is expressed as a percentage of the base figure. This is done by dividing each line item by the base figure and multiplying by 100.
- Step 3: Present the data: Finally, the data is presented in a tabular format, with each line item expressed as a percentage of the base figure. This allows for easy comparison and analysis.
For example, let's consider a company's income statement with sales as the base figure:
| Item | Amount | Percentage of Sales |
|---|---|---|
| Sales | $1,000,000 | 100% |
| Cost of Goods Sold | $600,000 | 60% |
| Gross Profit | $400,000 | 40% |
| Operating Expenses | $200,000 | 20% |
| Net Profit | $200,000 | 20% |
In this example, each line item is expressed as a percentage of sales, allowing for a clear understanding of the company's cost structure and profitability.
Benefits of Using a Common Size Financial Statement
The use of a Common Size Financial Statement offers several benefits:
- Comparison between companies: By expressing financial data as a percentage of a base figure, it becomes easier to compare the performance of different companies. This is particularly useful when analyzing companies operating in different industries or of different sizes.
- Identification of trends: A Common Size Financial Statement allows for the identification of trends over time. By comparing the percentages of different line items across different periods, it becomes easier to spot changes in a company's financial performance.
- Insights into cost structure: By expressing costs as a percentage of sales, a Common Size Financial Statement provides insights into a company's cost structure. This can help identify areas where costs are high relative to sales and where cost-saving measures can be implemented.
Case Study: Comparing Two Companies Using Common Size Financial Statements
Let's consider a case study to illustrate the use of Common Size Financial Statements in comparing two companies operating in the retail industry: Company A and Company B.
Company A:
| Item | Amount | Percentage of Sales |
|---|---|---|
| Sales | $1,000,000 | 100% |
| Cost of Goods Sold | $600,000 | 60% |
| Gross Profit | $400,000 | 40% |
| Operating Expenses | $200,000 | 20% |
| Net Profit | $200,000 | 20% |
Company B:
| Item | Amount | Percentage of Sales |
|---|---|---|
| Sales | $2,000,000 | 100% |
| Cost of Goods Sold | $1,200,000 | 60% |
| Gross Profit | $800,000 | 40% |
| Operating Expenses | $400,000 | 20% |
| Net Profit | $400,000 | 20% |
By comparing the Common Size Financial Statements of Company A and Company B, we can gain valuable insights into their relative performance. In this case, we can see that both companies have the same gross profit margin of 40%, indicating similar levels of profitability on their sales. However, Company B has a higher net profit margin of 20% compared to Company A's net profit margin of 20%. This suggests that Company B is more efficient in managing its operating expenses and generating higher profits.
Conclusion
The Common Size Financial Statement is a powerful tool that allows for easy comparison and analysis of financial data. By expressing each line item as a percentage of a base figure, it provides insights into a company's performance, cost structure, and trends over time. Whether you are comparing companies operating in different industries or analyzing a company's performance over time, the Common Size Financial Statement can help you make informed financial decisions. So, the next time you analyze financial statements, consider using the Common Size Financial Statement to gain valuable insights into the numbers.