How to Build Common-Size Financial Statements

The graph for many companies would start with gross revenue followed by a reduction for the cost of goods. Next would be reductions for sales and administrative costs to arrive a pre-tax net oprating income. Banks prepare quarterly call reports, which include a balance sheet, income statement, and many other financial schedules. The regulators create Uniform Bank Performance Reports (UBPRs) from those, which anyone can get from the internet. Some of you may have found my earlier examples a little simplistic.

It’s a further drill-down into the components of ROA that I showed earlier. This company has a high cash ratio but may have a major investment in the following year they are preparing for. For the Level II exam, I endeavoured not to repeat the mistakes I made. Based on the Pareto 80/20 principle, I learnt to extract the most essential bits from the curriculum enough to give me that 80% result to pass.

1. It indicates the efficiency of production processes and pricing strategies relative to revenue.
2. This format is crucial for financial analysis because it emphasizes the proportion of expenses, revenues, and profits.
3. With the help of the comparison between the Common-size Income Statements of different periods, one can understand the efficiency in earning revenues and incurring expenses.
4. The power of revenue as a base number carries from the income statement to the statement of cash flows.
5. 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.
6. The basic formula for common-size financial statement analysis is to take a line item, divide it by a base amount (e.g., total assets or total revenue), and then express the result as a percentage.

On the balance sheet, analysts commonly look to see the percentage of debt and equity to determine capital structure. They can also quickly see the percentage of current versus noncurrent assets and liabilities. Financial statements that show only percentages and no absolute dollar amounts are common-size statements. All percentage figures in a common-size balance sheet are percentages of total assets while all the items in a common-size income statement are percentages of net sales. The use of common-size statements facilitates vertical analysis of a company’s financial statements.

What are common size statements?

However, if the companies use different accounting methods, any comparison may not be accurate. Common size financial statements can be used to compare multiple companies at the same point in time. A common-size analysis is especially useful when comparing companies of different sizes. It often is insightful to compare a firm to the best performing firm in its industry (benchmarking). To compare to the industry, the ratios are calculated for each firm in the industry and an average for the industry is calculated. Comparative statements then may be constructed with the company of interest in one column and the industry averages in another.

8: Common-Size Statements

It standardizes financial data, allowing businesses to compare performance across different periods or with other companies, regardless of size. One challenge with financial statement analysis is that many of the techniques we use help provide context for analysis, but they typically also have some flaws. First, EPS refers to earnings per share and is simply (for the purposes of this class) net income divided by number of shares outstanding.

How do you calculate percentages in a common size income statement?

Gross profit margin can be increased by raising prices or reducing production costs, while net profit margin measures the profit generated after considering all expenses. The key benefit of a common-size analysis is that it allows for a vertical analysis by line item over a single period, such as quarterly or annually. It also allows you to view a horizontal perspective over a period such as the three years that were analyzed in our example. It standardizes financial data, making it easier to compare with other periods or companies, irrespective of their size. Common-Size Statement does not help to take decisions since there is no standard ratio/percentage regarding the change of percentage in the various component of assets, liabilities, sales etc. Most accounting computer programs, including QuickBooks, Peachtree, and MAS 90, provide common-size analysis reports.

Using Clear Lake Sporting Goods’ current balance sheet, we can see how each line item in its statement is divided by total assets in order to assemble a common-size balance sheet (see Figure 5.22). 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. This graph starts with interest income as a percentage of assets, which is then reduced by interest expense.

1. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses.
2. 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.
3. Those companies could focus on better collection of receivables, fewer credit sales, or improved inventory management (e.g., a more just-in-time production process).
4. You can use it to see how your business stacks up percentage-wise with another business, even if that business is substantially larger.
5. While traditional financial statements present figures in monetary terms, common size statements express each line item as a percentage of a base figure, enabling a more straightforward comparison.
6. Each financial statement uses a slightly different convention in standardizing figures.

You may have noticed the small trendline between the line titles and their amounts. The report provides a graphical horizontal analysis and a numerical vertical analysis. While useful, common-size statements may oversimplify complex financial information and overlook qualitative factors affecting performance. They rely heavily on accurate data input and may not capture nuances unique to specific industries or business models. We’ve learned how to use ratios and common-size statements to study and compare companies. In our next lesson, we’ll wrap up this topic with a brief discussion on comprehensive income.

Note that although we have compared just two years of data for Charlie and Clear Lake, it is more common to use several years of data to get a more robust view of long-term trends. Note that rounding issues sometimes cause subtotals in the percent column to be off by a small amount. This Site cannot and does not contain legal, tax, personal financial planning, or investment advice. The legal, tax, personal financial planning, or investment information is provided for general informational and educational purposes only and is not a substitute for professional advice. Accordingly, before taking any actions based on such information, we encourage you to consult with the appropriate professionals. We do not provide any legal, tax, personal financial planning, or investment advice.

It is an essential tool for internal performance assessment, investment evaluation, credit analysis, and financial planning. Common size statements help standardize financial data for analysis purposes. By representing each item as a percentage of a common base, typically total assets or revenue, comparisons become more meaningful and insightful.

I still use these when deciding whether to invest in a bank’s stock or to assess their financial health before placing a deposit with them. This example is from banking, but the concepts apply to common-size analysis for most industries. This tool is especially important if you’re using key performance indicators to common size statement analysis measure your business’s performance and profitability. The approach lets you compare your business to your competitors’ businesses, regardless of size differences. Common size statements also can be used to compare the firm to other firms.

This certainly spurs us on to produce more materials to ease the burden of CFA candidates worldwide. I naturally neglected the preparation for my Level I exam in June 2014. It was not until the middle of March 2014 that I realized I only had a little more than 2 months to the exam. To compound my problems, I basically did not have a preparation strategy. Having no background in finance at all, I tried very hard to read the curriculum from cover to cover, but eventually that fell flat. I can still recall the number of times I dozed off while studying, or just going back and forth trying to understand even the simplest concept.

Common-size financial statements are often prepared for a balance sheet or an income statement. A cash flow statement can also be prepared in a common-size format. The basic formula for common-size financial statement analysis is to take a line item, divide it by a base amount (e.g., total assets or total revenue), and then express the result as a percentage. 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.