Common Size Financial Statements As An Analytical Tool.
Using common size methodology to analyze the financial statements like the Income Statement and Balance Sheet are extremely useful as it removes bias particularly when the companies are of differing sizes. Common financial statements enable us to do easy analysis between companies or between time periods of a company.
It allows us to analyze the company over various time periods, revealing, for example, what percentage of sales is cost of goods sold and how that value has changed over time or what percentage of total assets is inventory/receivables and how that value has changed over time.
So what is really common size financial statements?
Common size methodology is simply displaying or formatting all items whether in the balance sheet or income statement as percentages of a common base figure.
In the case of an income statement, the common base is the revenue whilst in the balance sheet it can be the total assets/total liabilities.
Common size financial statement is one of the principal tools used in ratio analysis as most firms don’t report their statements in common size, it is beneficial to compute if we want to analyze two or more companies of differing size against each other.
Let’s look at a simple Income Statement – a normal one and then compared with a Common size :
A normal Income Statement
|
In Thousand(‘000) |
Year 2006 |
Year 2005 |
|
Sales |
15,000 |
11,000 |
|
COGS |
10,000 |
8,000 |
|
Gross Profit |
5,000 |
3,000 |
|
Operating Costs |
1.000 |
1,100 |
|
Operating Profit |
4,000 |
1,900 |
|
Other Incomes |
100 |
50 |
|
Profit Before Tax |
4,100 |
1,950 |
|
Line |
|
Year 2006 |
Year 2005 |
Year 2006 |
Year 2005 |
|
|
Revenues |
15,000 |
11,000 |
100.0% |
100.0% |
|
|
COGS |
10,000 |
8,000 |
66.7% |
72.7% |
|
1 |
Gross Profit |
5,000 |
3,000 |
33.3% |
27.3% |
|
2 |
Operating Costs |
1.000 |
1,100 |
6.6% |
10.0% |
|
|
Operating Profit |
4,000 |
1,900 |
26.7% |
17.3% |
|
3 |
Other Incomes |
600 |
50 |
4.0% |
0.5% |
|
|
Profit Before Tax |
4,600 |
1,950 |
30.7% |
17.8% |
Line (1) – gross profit have improved from 27.3% in 2005 to 33.3% – why?
Line (2) - operating costs also improved from 10% to 6.6% – why?
As a result now we know what caused the improvement in operating profit
But what is this “ other incomes” under Line 3 from a meager 0.5% have rose to 4.% of total revenues?
Is it common for this type of company to have such high other income – is it exceptional re: one time affair which might distort the profit before tax.
If we want to delve further, we should go into details into the operating cost (line2) or we can put up a detailed financial statement for inter-companies comparies.
Next what about the common size Balance sheet :
With a common-size balance sheet that displays all items as percentages of a common base figure like total assets, it assist us to perform analysis between companies or between time periods of a company.
Simple Illustration:
A normal Balance Sheet
|
In Thousand(‘000) |
Year 2006 |
Year 2005 |
|
Cash |
2,000 |
1,200 |
|
Inventory |
3,300 |
2,000 |
|
Receivables |
4,,500 |
2,000 |
|
Investments |
2,000 |
1,500 |
|
Total Assets |
11,800 |
6,700 |
Translated into a Common Size Balance Sheet
|
Line |
In Thousand(‘000) |
Year 2006 |
Year 2005 |
Year 2006 |
Year 2005 |
|
1 |
Cash |
1,000 |
3,200 |
8% |
48% |
|
2 |
Inventory |
4,300 |
1,000 |
36% |
15% |
|
3 |
Receivables |
4,500 |
1,000 |
39% |
15% |
|
4 |
Investments |
2,000 |
1,500 |
17% |
22% |
|
5 |
Total Assets |
11,800 |
6,700 |
100% |
100% |
Salient points:
o In the normal balance sheet, account values are expressed in dollar terms, while
o in the common size one, each value is listed as a percentage of total assets.
o This is also done for liabilities, where each liability account is a percentage of total liabilities
Reviewing the common sized balance sheet, line 1-3 showed a drastic decline of holding cash and more investments into inventory and receivables.
- Principal Tools Of Analysis Of Financial Statements
- Simple Guides To The Analyzing Of The Financial Statements In The Annual Report
- All Topics Under The Heading Of Financial Accounting Ratio Analysis Or The Interpretation Of Financial Statements In The Annual Report
- Income Statement In The Financial Statements ( Part 3)
- Financial Statements – Balance Sheet & Its Components (Part 2)
- Technical Summary Of IAS 1 Presentation of Financial Statements
- Brand Valuation As A Defence Tool In An Acquisition
March 21, 2007
Posted in: For Companies
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