How to Prepare and Analyze Common Size Statements

Common size financial statements convert raw data from a company’s balance sheet and income statement into percentages. This standardization removes the effects of size, allowing for more direct comparisons. An analyst can evaluate a company’s performance over several years or compare it to a competitor of a different scale, making it easier to identify trends and structural changes.

Core Concepts of Common Size Statements

The method for creating common size statements is known as vertical analysis. This technique expresses each line item on a financial statement as a percentage of a base figure from that same document. This reveals the relative importance of each account within a single period.

For an income statement, the base figure is total revenue or net sales. Every expense, cost, and profit figure is divided by total revenue. This calculation reveals what percentage of revenue is consumed by the cost of goods sold, what is spent on operating expenses, and what remains as net income.

When creating a common size balance sheet, the base figure is total assets. Each asset, liability, and equity account is shown as a percentage of total assets. This illustrates the company’s asset composition and how its assets are financed, whether through debt or equity.

How to Prepare Common Size Statements

To prepare common size statements, you must first obtain the standard financial statements for the periods you intend to analyze. The complete income statement and balance sheet are found in a company’s annual report (Form 10-K) or quarterly report (Form 10-Q).

For the income statement, divide each line item by the total revenue for the period and multiply the result by 100. The formula is (Individual Line Item / Total Revenue) 100. This process is repeated for every item on the statement.

| Income Statement Item | Amount | Calculation | Common Size % |
| :— | :— | :— | :— |
| Total Revenue | $500,000 | ($500,000 / $500,000) \ 100 | 100.0% |
| Cost of Goods Sold | $300,000 | ($300,000 / $500,000) \ 100 | 60.0% |
| Gross Profit | $200,000 | ($200,000 / $500,000) \ 100 | 40.0% |
| Net Income | $50,000 | ($50,000 / $500,000) \ 100 | 10.0% |

The preparation of a common size balance sheet follows a similar logic, but the base figure is total assets. The formula is (Individual Line Item / Total Assets) 100. Every asset, liability, and equity account is divided by the total asset value.

| Balance Sheet Item | Amount | Calculation | Common Size % |
| :— | :— | :— | :— |
| Cash | $100,000 | ($100,000 / $1,000,000) \ 100 | 10.0% |
| Accounts Receivable | $250,000 | ($250,000 / $1,000,000) \ 100 | 25.0% |
| Total Liabilities | $400,000 | ($400,000 / $1,000,000) \ 100 | 40.0% |
| Total Equity | $600,000 | ($600,000 / $1,000,000) \ 100 | 60.0% |
| Total Assets | $1,000,000 | ($1,000,000 / $1,000,000) \ 100 | 100.0% |

Analyzing Financial Health Using Common Size Statements

One technique is internal trend analysis, which involves comparing a company’s common size statements over multiple periods, such as three to five years. This can reveal shifts in financial structure. For instance, if the percentage of COGS relative to sales consistently increases, it signals that the company’s profit margins are eroding.

A decreasing percentage for selling, general, and administrative (SG&A) expenses over time suggests improvements in operational efficiency. On the balance sheet, a growing percentage of accounts receivable could indicate the company is having difficulty collecting payments from its customers.

Another application is peer and industry comparison, which sets a company’s statement against its direct competitors or industry averages. This provides context to determine if the company’s financial structure is normal for its sector. For example, a company might find its inventory is 40% of its assets, while the industry average is 25%.

This discrepancy could suggest inefficient inventory management. Similarly, comparing the percentage of debt to total assets against a competitor’s can reveal differences in financial risk. If a company’s debt-to-asset percentage is significantly higher than the industry benchmark, it might be considered overleveraged during economic downturns.