Common Size Analysis: How to Compare Companies of Different Sizes

Similarly, one company may use the straight-line method for depreciation, while another may use the double-declining balance method. This can affect the net income and the fixed asset turnover ratios, which can also affect the common-size analysis. Therefore, common-size analysis should be used with caution when comparing companies that use different accounting policies, methods, and assumptions. One of the challenges of financial analysis is to compare the performance and financial position of different companies, especially when they vary in size, industry, and geographic location. Common-size analysis is a technique that helps overcome this challenge by expressing the financial statements of different companies in comparable terms.

Margin Size

Common size financial statements compare the performance of a company over periods of time. The information can be compared to competitors to see how well it is performing. You would do this for each of the other line items to determine the common size income statement figures.

To perform a common size analysis, you need the financial statements of the company you wish to evaluate. Based on the accounting equation, this also equals total liabilities and shareholders’ equity, making either term interchangeable in the analysis. It’s also possible to use total liabilities to indicate where a company’s obligations lie and whether it’s being conservative or risky in managing its debts. One of the benefits of using common size analysis is that it allows investors to identify large changes in a company’s financial statements.

• The assets, liabilities, and share capital is represented as a percentage of total assets.
• By standardizing financial statements, nonprofit organizations can compare their expenditure patterns with other organizations, or measure their progression against strategic goals over several years.
• That includes cost of goods sold, administrative expenses, or income after taxes.
• One of the main benefits of common-size analysis is that it allows us to compare the financial performance and position of companies of different sizes and industries.
• CFI is the global institution behind the financial modeling and valuation analyst FMVA® Designation.
• This method provides a clear view of how much of each dollar earned is consumed by various costs and expenses.

Balance Sheet Common Size Analysis

To perform a vertical analysis, each line item is divided by the chosen reference item and shown as a percentage. For example, if a company’s total revenue is $100,000 and its cost of goods sold is $40,000, then the cost of goods sold is 40% of the total revenue. Vertical Common Size Analysis is a method where each line item on a company’s financial statement is listed as the percentage of a single, reference item. For an income statement, this reference item is usually Gross Sales or Revenue, and for a balance sheet, it’s typically Total Assets or Total Equity. Banks use the technique to assess the financial health and creditworthiness of companies seeking loans.

• One of the best examples of a common size financial statement is to take a look at the sales revenue on an income statement.
• Therefore, the value of any method, including common size analysis, depends largely on the question you are trying to answer with your financial analysis.
• The technique can be used to analyze the three primary financial statements, i.e., balance sheet, income statement, and cash flow statement.
• In order to help you advance your career, CFI has compiled many resources to assist you along the path.

In the case of the Income Statement, each element of income and expenditure is defined as a percentage of the total sales. The assets, liabilities, and share capital is represented as a percentage of total assets. Yes, common size analysis can be used for both income statements and balance sheets. It provides insights into the composition of assets, liabilities, and equity.

For instance, ratio analysis can provide concrete numerical values reflecting a company’s financial performance, while common size analysis offers a view into how income or assets are distributed. By comparing these percentages year on year, you can understand if your company’s sustainability efforts are increasing or decreasing. Thus, applying common size analysis might aid in maintaining the right balance between profitability and sustainable operations.

Common size financial statement analysis involves converting the numbers in a financial statement into percentages relative to a common base. It allows for easy comparison and identification of trends within a company’s financial performance over time. Common size analysis is typically conducted on the income statement and the balance sheet. Financial statements provide a summary of a company’s financial activities, including its income, expenses, assets, and liabilities.

You may need to take into account factors such as the general state of the economy, the competitive environment, and the company’s operational issues. Let’s now perform the common size of the Income Statement for different periods and analyze the same on the stand-alone period basis and for different years. This tool is especially important if you’re using key performance indicators to measure your business’s performance and profitability. The approach lets you compare your business to your competitors’ businesses, regardless of size differences. The practical applications of common size analysis (CSA) span across a wide range of industries and arise in numerous contexts. We believe everyone should be able to make financial decisions with confidence.

It also shows the impact of each line item on the overall revenue, cash flow or asset figures for your company. A common size balance sheet helps in evaluating a company’s asset structure, liabilities, and equity in relation to total assets, which simplifies comparison between companies of different sizes. One version of the common size cash flow statement expresses all line items as a percentage of total cash flow. A common size analysis can also be performed on the liabilities that a company has, or it can be performed on its balance sheet as a whole. In this way, elements of a company’s operations like debt, shareholder equity, and cost of goods sold can be measured against the financial operations as a whole. The only limit to such analysis is the potential for faulty accounting practices to skew the numbers on which the percentages are based.

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One of the most useful tools for analyzing balance sheets is common-size analysis. Common-size analysis can reveal important insights about a company’s liquidity, solvency, efficiency, and profitability. In this section, we will discuss how to perform common-size analysis on balance sheets and what to look for when comparing different companies. We will also provide some examples of common-size analysis applied to real-world companies. To perform a common size income statement analysis, you’ll compare every line on your profit and loss statement to your total revenue. In other words, net revenue will be the overall base figure on your common size analysis formula.

Calculation of Percentages

When applied to income statements, common-size analysis helps to identify trends, patterns, and areas of strength or weakness in a company’s revenue and expense structure. When delving into income statements through the lens of common size analysis, the first aspect to consider is the proportion of revenue consumed by various expenses. By expressing each line item as a percentage of total revenue, one can quickly identify how efficiently a company is managing its costs. For instance, a high percentage of revenue allocated to the cost of goods sold (COGS) might indicate that the company is facing high production costs, which could be a red flag for investors. Conversely, a lower COGS percentage suggests better cost management and potentially higher gross margins.

We will also consider some of the limitations and challenges of using common-size analysis for this purpose. Under the solvency aspect, common size analysis can be useful in looking at long-term stability of a company. By expressing all balance sheet items as a percentage of the total assets, you common size statement analysis could compare the percentage of total liabilities with industry benchmarks. It can show analysts whether a company has an unusual level of long-term debt for its industry. A high percentage might indicate that the firm is overly reliant on loans, which can be a risk for long-term solvency. Furthermore, common size analysis serves as an indispensable tool for detecting historical trends and patterns in a company’s financial performance.

Common size vertical analysis lets you see how certain figures in your business compare with a selected figure in one given time period. For example, you might use it to see what percentage of your income is used to support each business expense. By using common size analysis, comparisons can be more easily made both across time and across the industry. Putting the current numbers up against the benchmark would allow the company to see where its operations might be lacking.

Why Is Common Size Analysis Important?

One of the main benefits of common-size analysis is that it allows us to compare the financial performance and position of companies of different sizes and industries. However, interpreting common-size analysis results requires some caution and context, as there are many factors that can influence the ratios and percentages. In this section, we will discuss some of the key points to consider when performing and interpreting common-size analysis. We will also provide some examples of how common-size analysis can reveal insights about the strengths and weaknesses of different companies. The income statement, when expressed in common size terms, typically uses total revenue as the base figure.

To find net income using the income statement equation, you simply minus sales from expenses. Common size analysis ignores absolute values and industry-specific factors, which may impact the overall interpretation of the financial statements. Companies within the same industry may have different operational structures, which can significantly impact their financial statements. Incorporating absolute figures and industry benchmarks alongside common size percentages can help mitigate these limitations. Share repurchase activity can also be considered a percent of the total top line.