Common Size Financial Statement Analysis
A common size financial statement is a form of financial statement analysis that demonstrates the actual dollar amounts for a balance sheet or income statement as well as the relative percentages for each of the dollar amount particulars.
Common size financial statements assists analyst to interpret certain businesses on a new level. By looking at a common size percentage an analyst can easily check where the company is very cost effective or not, and investor can look at the strategy of the company. There are 2 divisions of common size financial statements. The first is the common size income statement which takes all the income statement items and list it as a % of the total revenue. This permits a company to obtain information about the cost structure of the firm and permits investors to look at margin percentages as well. The second is the common size balance sheet which permits an analyst or investor to see what percentage the company invest in specified assets, and how the company finances the business deal whether it be through equity or debt. This permits an analyst or investor to observe the assets that bring forth the most wealth for the company which also brings out the overall strategy. The relative percentages of debt and equity permits the investor to see the way in which the company finances itself whether it be through an issuance or leverage. One downfall of the common size financial statement is that if an analyst is comparing two companies the relative size of the companies is not revealed through the percentage amounts. This means that what might seem like a healthy percentage for one firm may not be so for another. Overall, common size statements are widely employed and are very employable in the evaluation and comparison of companies.
Limitations
As with financial statements in general, the interpretation of common size statements is subject to many of the limitations in the accounting data employed to construct them. For example:
Different accounting policies may be employed by different firms or within the same firm at different points in time. Adjustments should be made for such differences.
Different firms may employ different accounting calendars, so the accounting periods may not be directly comparable.
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