Common Size Statement: Definition, Types, Formula & Preparation
Common size statements help in financial analysis by offering clarity and comparability among various companies and time frames. Discover more about this effective tool that equalizes opportunities for businesses of all sizes.
Uncover insights that go beyond raw numbers, revealing hidden trends and performance indicators.
Definition Of Common Size Statement
A common size statement is a financial analysis tool that helps in evaluating and comparing financial statements. It does this by showing each item as a percentage of a common base figure.
This approach simplifies the comparison of financial performance between various companies or time periods, regardless of their size.
Types Of Common Size Statement
Let us study the different types of common size statements:
Common Size Balance Sheet
A common size balance sheet is a way to present financial statements by showing each item as a percentage of total assets. This method aids in understanding the relative sizes of different components within a company's financial framework.
To prepare a common size balance sheet, each period's figures are divided by the base figure, usually total assets, to calculate the percentages.
Common Size Cash Flow
The common size cash flow statement presents each cash flow category as a percentage of the total cash flows from operating activities. This statement provides insights into how much cash is generated or used in different areas of a business.
Key components include operating activities, investing activities, and financing activities.
Common Size Income Statement
A common size income statement presents each item as a percentage of total sales or revenue. This format is crucial for financial analysis because it emphasizes the proportion of expenses, revenues, and profits.
By converting all figures into percentages of net sales, it simplifies comparisons between various companies or time periods.
Formula For Common Size Statement
The common size cashflow statement formula involves expressing each line item as a percentage of the total cash inflows or total cash outflows:
How To Prepare Common Size Statements
Let us study how the different types of common size statement are prepared with examples:
Common Size Income Statement
Step 1: Identify the base figure (total revenue).
Step 2: Divide each line item by the base figure (total revenue) to calculate the percentage.
Step 3: Present each line item as a percentage of total revenue.
Example
Suppose a company has a total revenue of INR 10,00,000, a cost of goods sold of INR 6,00,000, and operating expenses of INR 2,00,000.
Total Revenue: 100%
Cost of Goods Sold: 60% (INR 6,00,000 / INR 10,00,000)
Operating Expenses: 20% (INR 2,00,000 / INR 10,00,000)
Net Income: 20% (assuming no other expenses)
Common Size Balance Sheet
Step 1: Identify the base figure (total assets).
Step 2: Divide each line item by the base figure (total assets) to calculate the percentage.
Step 3: Present each line item as a percentage of total assets.
Example
Suppose a company has total assets of INR 20,00,000, cash of INR 5,00,000, accounts receivable of INR 3,00,000, and total liabilities of INR 12,00,000.
Total Assets: 100%
Cash: 25% (INR 5,00,000 / INR 20,00,000)
Accounts Receivable: 15% (INR 3,00,000 / INR 20,00,000)
Total Liabilities: 60% (INR 12,00,000 / INR 20,00,000)
Common Size Cash Flow Statement
To prepare a common size cash flow statement, follow these steps:
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Gather data: Obtain the cash flow statement for the period you want to analyze.
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Choose a base figure: Usually, net cash is provided by (or used in) operating activities.
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Convert each line item to a percentage: Divide each line item amount by the base figure and multiply by 100 to get the percentage.
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Prepare the common size statement: List each line item with its percentage of the base figure.
Practical Applications
Let us study some of the practical applications of common size statement:
Internal Management: Helps management assess operational efficiency and make informed decisions regarding cost control, pricing strategies, and resource allocation.
Investor Analysis: Investors use common size statements to evaluate a company's financial health, efficiency, and profitability relative to its peers.
Credit Analysis: To evaluate a business's creditworthiness, creditors examine common size statements. They pay particular attention to the company's capacity to fulfill both short-term and long-term financial responsibilities.
Merger and Acquisition Evaluation: Common size statements are used to compare financials of target companies, ensuring the acquirer understands the financial proportions and structure of the target.
Limitations
Lack of Absolute Values: While common size statements highlight proportions, they do not provide absolute values, which can be important for certain analyses.
Industry Differences: Different industries have different financial structures, making cross-industry comparisons less meaningful.
Historical Data: Common size statements are based on past data, but this information doesn't always provide an accurate forecast for future results.
Differences And Tips For Better Analysis
Differentiating between common size financial statements and traditional financial statements is essential. 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.
Standardization
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.
This standardization allows for a more accurate assessment of companies' financial health and performance.
Tips For Better Analysis
To enhance financial analysis, consider comparing common size statements over multiple periods. This helps in identifying trends and changes in financial performance.
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Utilize financial ratios alongside common size statements for a more comprehensive view of the company's financial health.
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Dive deeper into specific areas like income statement analysis or balance sheet analysis to gain a more nuanced understanding.
Conclusion
To sum up, a common size cash flow statement simplifies financial data by showing each item as a percentage of a key figure, typically the net cash generated from operating activities. This approach makes it easier to compare financial performance across various time periods, different companies, and industry standards.
It is an essential tool for internal performance assessment, investment evaluation, credit analysis, and financial planning. By highlighting trends and changes in cash flows, it offers clear insights into a company's financial health and operational efficiency, making it easier to identify strengths and areas for improvement.
Frequently Asked Questions (FAQs)
1. What are common size statements?
Common size statements are financial reports that express each item as a percentage of a key figure, usually total revenue or total assets. This approach simplifies the comparison of financial information between various companies or over different time periods.
2. Why are common size statements important?
Common size statements are valuable tools for evaluating and comparing the financial health of companies across various sizes and sectors. They reveal the relative percentages of different financial elements, helping to spot trends and support informed decision-making in business.
3. How can common size statements be prepared?
To prepare common size statements, each line item on the financial statement is divided by a base figure (such as total revenue or total assets) and multiplied by 100 to express it as a percentage. This process standardizes the data for better analysis and comparison.
4. In what real-world scenarios are common size statements useful?
Common size statements are commonly used by investors, analysts, and managers to evaluate companies' financial health, assess operational efficiency, and benchmark performance against industry peers. They are crucial tools in financial analysis, budgeting, and strategic planning processes.
5. What are the limitations of common-size statements?
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. Careful interpretation is essential for meaningful analysis.
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