What Are Common Size Financial Statements?

Financial statements offer a window into a company’s financial health, providing a structured overview of its economic activities. The income statement details revenues and expenses over a period, revealing profitability, while the balance sheet presents a snapshot of assets, liabilities, and equity at a specific point in time. Common size financial statements serve as a specialized analytical tool, enhancing the ability to interpret and compare this financial information more effectively.

Understanding Common Size Financial Statements

Common size financial statements transform traditional financial figures into percentages, allowing for a standardized view of a company’s financial structure. Each line item on these statements is expressed as a percentage of a specific base figure. For an income statement, the base figure is typically total revenue or sales, showing every expense and profit line as a proportion of sales. On a balance sheet, every asset, liability, and equity item is presented as a percentage of total assets.

This conversion standardizes the statements, making it possible to compare companies of different sizes or to analyze a single company’s performance across various periods. By reducing all figures to a common base, these statements highlight the relative importance of each financial component. They reveal the proportional breakdown of financial items, such as how much of each sales dollar is consumed by the cost of goods sold or what proportion of assets is financed by debt versus equity. This standardization facilitates a clearer understanding of financial trends and relationships that might be obscured by absolute dollar amounts.

Preparing Common Size Financial Statements

Creating common size financial statements involves a calculation process for each line item. For an income statement, every figure, including cost of goods sold, operating expenses, and net income, is divided by the total revenue for that period. For instance, if a company’s total revenue is $500,000 and its cost of goods sold is $200,000, the common size percentage for cost of goods sold would be 40% ($200,000 / $500,000). This calculation is applied consistently down the income statement.

For the balance sheet, each asset, liability, and equity account is divided by the total assets figure. For example, if total assets are $1,000,000 and cash is $150,000, cash represents 15% of total assets ($150,000 / $1,000,000). This process is repeated for all items, illustrating its proportion of the total assets. These percentages provide a clear picture of the company’s financial composition.

Analyzing with Common Size Financial Statements

Common size financial statements are valuable tools for gaining financial insights through comparative analysis. One primary use is trend analysis, where these statements are compared over multiple periods for the same company. This comparison can reveal shifts in cost structures, such as a rising percentage of cost of goods sold, which might indicate increasing production costs or less efficient operations. Similarly, observing changes in the percentage of operating expenses can highlight improvements or declines in operational efficiency.

Another significant application is in comparing a company’s financial performance against industry averages or competitors. Since common size statements standardize figures into percentages, they allow for meaningful benchmarking, even when companies vary greatly in size. For instance, if a company’s marketing expense as a percentage of sales is significantly higher than its competitors, it could suggest an aggressive growth strategy or inefficiency in marketing spend. These statements help illuminate profitability trends, such as gross profit and net profit margins, and provide insights into asset utilization and the financing mix between debt and equity.