How To Prepare a Common-Size Income Statement Analysis

On the other hand, if operating expenses were 24% of revenues this year and 25% of revenues last year, it could be said that expenses were stable, and the reader might move on from this without a pause. And, just like with the income statement, we must compare our numbers with the industry’s averages or with major competitors. For the balance sheet, line items are typically divided by total assets. For example, if Company A has $1,000 in cash and $5,000 in total assets, this would be presented in a separate column as 20% in a common size balance sheet. There is no mandatory format for a common size balance sheet, though percentages are nearly always placed to the right of the normal numerical results. If you are reporting balance sheet results as of the end of many periods, you may even dispense with numerical results entirely, in favor of just presenting the common size percentages.

Thus accountants using this type of software can focus more on analyzing common-size information than on preparing it. In fact, some sources of industry data present the information exclusively in a common-size format, and most of the accounting software available today has been engineered to facilitate this type of analysis. You’ll need a calculator to do the work by hand, but a spreadsheet program makes the work faster while also allowing you to make changes in a budget or forecast, and to see how the changes affect the rest of the data.

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Although this kind of analysis can be performed on many types of financial statements, the balance sheet and the income statement are most commonly analyzed using this tool. 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.

This type of analysis is often used when performing due diligence for an acquisition, a valuation or any other financial transaction. Common-size percentages, used in analyzing the balance sheet and also the income statement, are a calculation that sets each line item as a percent of one standard amount. On the balance sheet, you would set every other asset and liability line item as a percent of total assets. A https://personal-accounting.org/common-size-balance-sheet/ statement that shows the percentage relation of each asset/liability to the total assets/total of equity and liabilities, is known as a Common-size Balance Sheet. To express the amounts as the percentage of the total, the total assets or total equity and liabilities are taken as 100. With the help of a Comparative Common-size Balance Sheet of different periods, one can highlight the trends in different items.

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There isn’t an “industry standard” presentation, but typically, you would display a balance sheet with the actual numbers on the left, and the corresponding percentages on the right. Common-size Statements are accounting statements expressed in percentage of some base rather than rupees. An infinite number of uses and rational deductions can be made from performing a common-size analysis on a financial statement. It can be used to compare the company’s performance within one year, year on year, or against competitors. That said, companies often trade profitability for market share and, if successful, the rapid expansion of ABC can put the seemingly more conservative XYZ in a difficult position simply by becoming a larger competitor.

Generally speaking, a common-size financial statement is a type of analysis of an income statement that expresses each line of the statement as a percentage of sales. The common size income statement shows that the percentage of COGS has also gone up. This suggests that the firm should try to find quality material at a lower cost and lower its direct expenses if possible. Common size financial statement analysis, which is also called a “vertical” analysis, is a technique that financial managers use to analyze their financial statements.

Interpretation of a Financial Statement

If a Common-size Balance Sheet is prepared for the industry, it facilitates the assessment of the relative financial soundness and helps in understanding the financial strategy of the organisation. A company has $8 million in total assets, $5 million in total liabilities, and $3 million in total equity. Therefore, along with reporting the dollar amount of cash, the common size financial statement includes a column that reports that cash represents 12.5% ($1 million divided by $8 million) of total assets. When you show the items on the income statement as a percentage of the sales figure, it makes it easier to compare the income and expenses and understand the financial position of the company. Common size analysis is an excellent tool to compare companies of different sizes or to compare different years of data for the same company, as in the example below. A company could benchmark its financial position against that of a best-in-class company by using common size balance sheets to compare the relative amounts of their assets, liabilities, and equity.

However, net income only accounted for 10% of 2022 revenue, whereas net income accounted for more than a quarter of 2021 revenue. The company should look for ways to cut costs and increase sales in order to boost profitability. With a common size horizontal analysis, you can easily see if, for example, your expenses increased as a percentage of revenue, stayed the same or decreased among different time periods. A common-size analysis of the income statement will compare all line items in the statement to total sales. It will then take that information and compare it to previous, comparable reporting periods and to those on competitors’ income statements to determine whether the results were positive developments or negative. This can be used on the balance sheet to determine how cash compares to total assets.

Common Size Balance Sheet: Definition, Formula, Example

Note that rounding issues sometimes cause subtotals in the percent column to be off by a small amount. Operating profit is one of the most important numbers you can analyze because it shows the health of the business firm’s core business. Let’s carry on with our analysis of ABC, in comparison to its competitor XYZ. Cynthia Gaffney has spent over 20 years in finance with experience in valuation, corporate financial planning, mergers & acquisitions consulting and small business ownership. She has worked as a financial writer and editor for several online small business publications since 2011, including AZCentral.com’s Small Business section, The Balance.com, Bizfluent.com, and LegalBeagle.com.

It is also prepared to see the trends of different items of assets, equity and liabilities of a Balance Sheet. Most accounting computer programs, including QuickBooks, Peachtree, and MAS 90, provide common-size analysis reports. You simply select the appropriate report format and financial statement date, and the system prints the report.

Vertical analysis is especially helpful in analyzing income statement data such as the percentage of cost of goods sold to sales. Where horizontal analysis looked at one account at a time, vertical analysis will look at one YEAR at a time. This type of analysis is used to analyze a company’s financial statements to identify patterns and trend lines, and to compare a company against competitors. When figures are expressed as a percentage of a whole, analysts can assess how each part contributes relative to another. The next point of the analysis is the company’s non-operating expenses, such as interest expense. The income statement does not tell us how much debt the company has, but since depreciation increased, it is reasonable to assume that the firm bought new fixed assets and used debt financing to do it.

• Performing common-size calculations for several different time periods and looking for trends can be especially useful.
• Whenever you analyze your margins — gross profit, net profit or operating — you’re performing a common size analysis.
• For example, inventory might be a much larger percentage of total assets this year, which could mean the company’s chosen slow-moving merchandise needs to match prices with the competition.
• For this reason, the top line of the financial statement would list the cash account with a value of $1 million.
• A closer inspection of both data sets would yield even more useful information.
• ABC’s profitability may be lower, but its cash generation abilities cannot be questioned and so bankruptcy risk will be minimal and there will be no shortage of investors trying to get in on the action.
• For example, if Company A has $1,000 in cash and $5,000 in total assets, this would be presented in a separate column as 20% in a common size balance sheet.

If there are any fixed assets that can be sold, management should consider selling them to lower both the depreciation and interest expense on debt. For trend analysis, it’s useful to look at a company’s activity from one time period to the next. For example, inventory might be a much larger percentage of total assets this year, which could mean the company’s chosen slow-moving merchandise needs to match prices with the competition. Also, common-size balance sheets work very well for comparing a company to its competitors or to an industry standard.

It is not another type of income statement but is a tool used to analyze the income statement. The current assets formula determines that the “total current assets,” which are the total of all assets that can be converted to cash within one year, makes up 37% of the company’s total assets. In contrast, current liabilities, which are debts due within one year, make up only 30% of the company’s total assets. This common size income statement analysis is done on both a vertical and horizontal basis.