Common size financial statements are tools that enable easy comparison of financial performance across companies and time periods. By expressing each line item as a percentage of a base figure, common size statements provide insights into a company’s financial health, profitability, and expense management.

What Are Common Size Financial Statements?

A common size financial statement represents each line item as a percentage of a base figure. This allows businesses, investors, and analysts to compare financial data across companies of varying sizes, industries, and time periods. It simplifies understanding complex financial data by focusing on proportional relationships rather than absolute values.

Types of Common Size Financial Statements

1. Common Size Income Statement

   • This statement expresses each income and expense item as a percentage of total revenue. It allows for easy analysis of profitability and how expenses compare to income. For example, it helps assess whether a company’s expenses are growing faster than its revenues, thus highlighting areas that may need attention.

2. Common Size Balance Sheet

   • The common size balance sheet presents each asset, liability, and equity item as a percentage of total assets. This helps in understanding a company’s financial structure and its dependence on various financing sources. By comparing percentages, investors can assess the proportion of debt and equity used in financing assets.

Benefits of Common Size Financial Analysis

1. Simplified Comparisons

   • By converting all financial figures into percentages, common size statements make it easier to compare companies of different sizes. Whether comparing competitors in the same industry or analyzing a company’s performance over several years, these statements provide a clear view of financial health.

2. Trend Analysis

   • Common size analysis is an excellent tool for tracking financial trends over time. By observing how the percentage of various expenses, income, or assets changes over multiple periods, you can identify potential issues or growth areas. For example, if the percentage of total sales spent on marketing increases dramatically, it may indicate the company is aggressively pursuing market share.

3. Operational Insights

   • These statements reveal areas where a company may be overspending or underperforming. For instance, an unusually high percentage of revenue spent on raw materials may suggest inefficiency, prompting management to look into cost-cutting measures or negotiations with suppliers.

Limitations of Common Size Financial Statements

1. Lack of Absolute Values

   • Common size statements focus on relative percentages, which may obscure the scale of operations. For instance, a company with very high revenue may show a smaller percentage of expenses compared to a company with lower revenue, even though both companies have the same absolute expenses.

2. Industry Variations

   • Common size analysis does not always account for industry-specific factors. Different industries have different norms when it comes to expenses, assets, and liabilities. For example, technology companies may have higher R&D expenses, while manufacturing companies may have significant capital expenditures.

3. Non-Operational Factors

   • These statements may not include external factors that can impact a company’s financial performance, such as tax changes, changes in government regulations, or economic shifts. For a more complete understanding, it’s essential to consider these external influences alongside the financial data.

How to Use Common Size Statements

When analyzing financial statements, it’s essential to look beyond just the numbers. Comparing the common size statements of different companies, industries, or even different time periods gives you a better understanding of financial performance and trends.

For instance, if you are comparing the profitability of two companies in the same industry, a common size income statement allows you to assess which company is better at controlling its costs relative to its revenue.

Conclusion

Common size financial statements offer a useful way to compare financial data across companies and time periods. They provide simplified insights into a company’s profitability, financial structure, and cost management. However, it is essential to be aware of their limitations, such as the lack of absolute figures and potential industry variations.

By understanding how to use common size financial statements, you can make more informed decisions about investments or company performance evaluations.