Common Size

Common size analysis is a standard tool used to compare the financial statements of different companies by converting account groupings to a percentage of the whole, often sales revenues.
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Common Size

Common size is an analytical tool used in finance to compare financial statements of different companies. This method converts all items on a financial statement, such as income statements or balance sheets, to a percentage of a total, allowing for direct comparisons between companies of different sizes. It helps in identifying trends and understanding the financial health of a company relative to its competitors.

Examples

  1. Income Statement Common Size Analysis: If a company has sales revenues of $1,000,000 and cost of goods sold (COGS) of $400,000, the COGS would be 40% of sales. If another company has sales revenues of $500,000 and COGS of $200,000, its COGS would also be 40% of sales. Despite different revenues, the cost structure in percentage terms is comparable.

  2. Balance Sheet Common Size Analysis: A company with total assets of $2,000,000 and cash of $100,000 would show cash as 5% of assets. Another company with total assets of $1,000,000 and cash of $50,000 would also have 5% of its assets in cash. This percentage is useful for liquidity comparison.

Frequently Asked Questions

Q1: How does common size analysis help in financial comparison?

  • A1: Common size analysis converts financial statement items to percentages of a key figure, making it easier to compare companies of different sizes on an equal footing.

Q2: What is the most common base figure used in common size income statements?

  • A2: Sales revenues are typically used as the base figure, set at 100%, with other items expressed as a percentage of sales.

Q3: Can common size analysis be applied to all financial statements?

  • A3: Yes, common size analysis can be applied to income statements, balance sheets, and even cash flow statements.

Q4: What are the benefits of using common size analysis?

  • A4: This analysis helps in benchmarking, trend analysis, and highlights relative composition and financial relationships over time.

Q5: Is common size analysis helpful for understanding operational efficiency?

  • A5: Yes, by comparing expense ratios, it helps in identifying operational efficiencies or inefficiencies.
  • Vertical Analysis: Analyzing financial statement items as a percentage of a base figure within the same period.
  • Horizontal Analysis: Comparing financial data across multiple periods to identify trends.
  • Financial Ratios: Metrics calculated from financial statement items used for assessing various financial aspects of a company.

Online References

Suggested Books for Further Studies

  • “Financial Statement Analysis and Security Valuation” by Stephen H. Penman
  • “Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen
  • “Financial Reporting and Analysis” by Charles H. Gibson

Fundamentals of Common Size: Financial Analysis Basics Quiz

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