Additionally, the relative percentages may be compared across companies and industries. While common size balance sheets are not a requirement of generally accepted accounting principles (GAAP), they offer a number of benefits to both internal and external parties. A common size financial statement displays items as a percentage of a common base figure, total sales revenue, for example.

Common-size financial statements facilitate the analysis of financial performance by converting each element of the statements to a percentage. This makes it easier to compare figures from one period to the next, compare departments within an organization, and compare the firm to other companies of any size as well as industry averages. On the income statement, analysts can see how much of sales revenue is spent on each type of expense.

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. Common size financial statements reduce all figures to a comparable figure, such as a percentage of sales or assets. Each financial statement uses a slightly different convention in standardizing figures. Analysts also use vertical analysis of a single financial statement, such as an income statement.

Ultimately, positive cash flow from financing activities left the business with a positive cash position of $13,000. In the future, the company can improve by decreasing investment expenditures and increasing revenue from operating activities. This common size income statement analysis is done on both a vertical and horizontal basis. You can use it to see how your business stacks up percentage-wise with another business, even if that business is substantially larger.

How to Create Common-Size Income Statements in Excel

In this next section we will explore the requirements for what needs to be reported, when, and to whom. When comparing any two common size ratios, it is important to make sure that they are computed by using the same base figure. For example, large drops in the company’s profits in two or more consecutive years may indicate that the company is going through financial distress.

Figure 13.8 compares common-size gross margin and operating income for Coca-Cola and PepsiCo. In general, managers prefer expenses as a percent of net sales to decrease over time, and profit figures as a percent of net sales to increase over time. As you can see in Figure 13.5, Coca-Cola’s gross margin as a percent of net sales decreased from 2009 to 2010 (64.2 percent versus 63.9 percent). Income before taxes increased significantly from 28.6 percent in 2009 to 40.4 percent in 2010, again mainly due to a one-time gain of $4,978,000,000 in 2010. This caused net income to increase as well, from 22.0 percent in 2009 to 33.6 percent in 2010. In the expense category, cost of goods sold as a percent of net sales increased, as did other operating expenses, interest expense, and income tax expense.

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. A common size balance sheet is a balance sheet that displays both the numeric value and relative percentage for total assets, total liabilities, and equity accounts. Common size balance sheets are used by internal and external analysts and are not a reporting requirement of generally accepted accounting principles (GAAP). Common size analysis common size balance sheet format displays each line item of your financial statement as a percentage of a base figure to help you determine how your company is performing year over year, and compared to competitors.

1. To demonstrate the format of the balance sheet a typical layout is shown in the example below.
2. It mainly applies when the financials are compared over a period of two or three years.
3. 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.
4. Formatting financial statements in this way reduces bias that can occur and allows for the analysis of a company over various periods.
5. To find net income using the income statement equation, you simply minus sales from expenses.

It also shows the impact of each line item on the overall revenue, cash flow or asset figures for your company. The main difference is that a common size balance sheet lists line items as a percentage of total assets, liability, and equity, which is different from the normal numerical value. With regular financial statements, you would have line items listed as their total amounts. When it comes to common size financial statements, each line item gets expressed as a specific percentage of revenue or sales.

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Rapid increases or decreases will be readily observable, such as a fast drop in reported profits during one quarter or year. We believe everyone should be able to make financial decisions with confidence. Jami Gong is a Chartered Professional Account and Financial System Consultant.

Chapter 2: Reconstitution of a Partnership Firm: Change in Profit Sharing Ratio

By looking at this common size income statement, we can see that the company spent 10% of revenues on research and development and 3% on advertising. It precisely matches the common-size analysis from an income statement perspective. A Vertical Analysis of Financial Statements of a company, in which the amount of individual items of a Balance Sheet of Statement of Profit & Loss are written, is known as a Common Size Financial Statement. The percentages calculated by taking the respective common bases are then compared with the corresponding percentages of other periods, through which meaningful conclusions can be drawn. A Common-size Statement can be prepared for inter-firm and intra-firm comparisons or a Balance Sheet and Income Statement.

For example, you could determine the proportion of inventory using the balance sheet by using total assets as your base item. As you can see from Figure 13.6, the composition of assets, liabilities, and shareholders’ equity accounts changed from 2009 to 2010. A Common-size Balance Sheet represents all line items, on both asset and liabilities sides, as a % of total assets. The cash flow statement in terms of total sales indicates that it generated an impressive level of operating cash flow, averaging 26.9% of sales over three years. 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.