What Is Common Size Analysis in Accounting?

Common size analysis is an analytical tool in accounting that transforms financial figures into a more digestible format. It expresses each line item on a financial statement as a percentage of a chosen base figure. This allows for a clearer understanding of a company’s financial data, helping users evaluate performance and financial position.

Defining Common Size Analysis

For an income statement, common size analysis uses total revenue or sales as the base figure. Every expense, gain, and loss is then shown as a percentage of that total revenue. This standardization allows for a direct comparison of how different components contribute to or consume revenue.

On a balance sheet, total assets serve as the base figure. Each asset, liability, and equity account is expressed as a percentage of total assets. This reveals the composition of a company’s assets and how they are financed. Common size analysis standardizes financial statements, enabling comparisons across different periods or between companies of varying sizes.

Applying Common Size Analysis to Financial Statements

To create a common size income statement, divide each line item by the total revenue for the period. For example, the cost of goods sold is divided by total revenue and multiplied by 100. This calculation applies to all revenue, expense, and profit lines, down to net income. The resulting percentages show how much of each revenue dollar is allocated to costs or contributes to profit.

For a common size balance sheet, divide each asset, liability, and equity account by the total assets. For instance, accounts receivable is divided by total assets and multiplied by 100. This procedure applies to all accounts, from cash to retained earnings. These percentages illustrate the proportional makeup of a company’s assets and its capital structure.

Understanding the Insights from Common Size Analysis

Common size analysis provides insights through internal trend analysis and external comparisons. Examining a company’s common size statements over several periods reveals shifts in its financial structure or operational efficiency. For example, a rising percentage for administrative expenses might indicate increasing overhead costs relative to revenue, prompting further investigation.

The standardized nature of common size statements enables cross-company or industry comparisons, regardless of absolute size differences. A company can compare its common size cost of goods sold to competitors or industry averages to see if its production costs are proportionally higher or lower. This helps in understanding a company’s relative industry position and highlights areas for improvement.